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Tax Liability Comparisons: partnership, "S" & "C"

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June and John decide to start a business. They plan to contribute $20,000 in exchange for a 50 percent interest in the business. They expect that the business will make a profit of $80,000 in the first year and that it will not make any cash distributions that year. Excluding the business income, June, who files as the head of household, has $350,000 of other taxable income. John is married and files a joint return. He and his wife have $79,500 worth of other taxable income.

They want to know how much tax the business will pay and how much additional tax they will personally pay if they form the business as a partnership, S corporation, or C corporation. Consider only income taxes.

Be sure to identify the various factors of each business entity before coming to a conclusion.

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Solution Summary

The solution presents a comparison between June and John having a "C" corporation as opposed to a partnership or "S" corporation. Detailed tax calculations show the numerical difference between the two scenarios.

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Since both a partnership and an S corporation are pass-through entities, the 50% interest in the profits will be reported and taxed on the personal returns for June and John. The C corporation, on the other hand, pays its own tax.

The problem says to consider only income taxes, but it should be noted that the business profits are undoubtedly self employment income from an active trade or business, and FICA/Medicare tax would be added to their personal returns. There are also factors such as liability protection, taxation of dividends/distributions not addressed.

Any limitations that might be reached because of high personal income has been ignored for these calculations of individual ...

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