Piper plans to organize a new business venture as a corporation and wants to know if it is more tax-efficient to be an S-Corporation or C-Corporation. Piper projects the business will generate $200,000 in taxable income annually. Piper’s marginal tax rate is 37% for ordinary income and 20% for qualifying dividends and long-term capital gains. Piper has income from other sources, subjecting her to the 3.8% net investment income tax.
Piper projects that the new business will distribute 100% of its after-tax earnings every year to its shareholders. Piper’s only involvement with the entity will be as a capital investor. That is, Piper will not be actively engaged in business activities and is considered a passive investor. Finally, any business income allocation from a flow-through entity will qualify for the qualified business income deduction without any limitation.
a) Compute Piper’s after-tax income for each potential entity form (one calculation for forming as an S-Corporation and another for forming as a C-Corporation). (show your work).
b) What is the overall tax rate (combined owner and entity level) for organizing the business as an S corporation and as a C-Corporation? (show your work)?