You intend to start a new aerospace business called Space Ace, but before launching your new enterprise some due diligence is necessary to evaluate your organizing, financing, and investing options. Because of the differing liability and tax treatments you are contemplating organizing your business as either a sole proprietorship or corporation. Based on contract negotiations with NASA, you estimate that starting out your new business will generate $10.5 million in yearly pretax operating income.

Assume that the income you receive from your new business is your only income.

To finance your new business’ operations you are considering using 100% equity financing or a mix of 60% equity and 40% debt financing. If your business uses debt, it will have a yearly interest expense of $1.05 million.

In addition to the pretax operating income, your new business will receive $144,000 in dividend income on its investment in FliHi Satellites, Inc. and $59,000 in interest income on its investment in a primary supplier’s bonds. The dividend income qualifies for the 50% dividend exclusion.

TO DO

Create a spreadsheet to evaluate your organizing, financing, and investing options:

a. Calculate the total tax liability on Space Ace’s pretax operating income if it’s organized as a sole proprietorship versus a corporation. What are your observations?

b. Calculate the total tax liability on Space Ace’s pretax operating income, both as a sole proprietorship and a corporation, if it’s financed using 100% equity versus 60% and 40% debt. What are your observations?

c. Calculate the total tax liability on all of Space Ace’s income, both as a sole proprietorship and a corporation, if it’s financed using 100% equity versus 60% and 40% debt. What are your observations?