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Taxation: Benton Company (BC) Tax Calculations

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Benton Company (BC) has one owner, who is in the 35% Federal income tax bracket. BC's gross income is $200,000 and its ordinary trade or business deductions are $97,000. Compute the tax liability on BC's income for 2007 under the following assumptions:

A) BC is operated as a proprietorship, and the owner withdraws $70,000 for personal use.

B) BC is operated as a corporation, pays out$70,000 as salary, and pays no dividends to it shareholder.

C) BC is operated as a corporation and pays out no salary or dividends to its shareholder.

D) BC is operated as a corporation, pays out $70,000 as salary to its shareholder, and pays out the remainder of its earnings as dividends.

E) Assume Robert Benton of 1121 Monoroe street, Ironton, OH 45638 is the owner of BC, which was operated as a proprietorship in 2007. Robert is thinking about incorporating the business in 2008 and asks your advice. He expects about the same amounts if income and expenses in 2008 and plans to take $70,000 per year out of the company whether he incorporates or not. Write a letter to Robert [based on your analysis in (a) and (b) above] containing your recommendations.

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Solution Preview

A. BC will pay tax on all the profits when reporting as a sole proprietorship. It doesn't matter whether he withdrew the funds of not. The tax calculation would be $200,000 - 97,000 x 35% = $36,050. This analysis ignores any state tax or other income/deductions.

B. Assuming BC is a C Corporation, Robert will pay tax of $70,000 x 35% = $24,500. This scenario ignores any corporate taxes and any state income tax on either the corporation or the individual. Payroll taxes savings are also ignored.

C. Assuming BC is a C Corporation, Robert will pay no personal income tax because he took no salary or dividends from the ...

Solution Summary

The solution explains the tax rationale for each of the problems and includes calculations of taxable income and income tax. For the letter to Robert, there are 6 points favoring the formation of a C Corporation and 6 points of disadvantage to that strategy.