FI 360 Financial Management
June 5, 2013
Unit 1: Week 1 - Homework-1
P1-1. a. Calculate the tax disadvantage to organizing a U.S. business today as a corporation, as compared to a partnership, under the following conditions. Assume that all earnings will be paid out as cash dividends. Operating income (operating profit before taxes) will be $500,000 per year under either organizational form. The tax rate on corporate profits is 35 percent (Tc = 0.35), the average personal tax rate for the partners is also 35 percent (Tp = 0.35), and the capital gains tax rate on dividend income is 15 percent (Tdiv = 0.15). ANSWER P1-1a. a. If under these conditions as a partnership, operating income will be taxed only once, so
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But if organized as a corporation, operating income will be taxed once at the corporate level and again at the personal level, so investors will receive only $500,000 (10.35)(10.386) = $199,550. Partners thus pay a total tax rate of 38.6 percent on business income, while corporate shareholders pay a combined tax rate of 60.09 percent [1– (10.35)(1–0.386)] on this income, the “Corporate Tax Wedge” is the difference between these two rates, or 21.49 percentage points (60.09%38.6%).
P1-2. Calculate the tax disadvantage to organizing a U.S. business as a corporation versus as a partnership under the following conditions. Assume that all earnings will be paid out as cash dividends. Operating income (operating profit before taxes) will be $3,000,000 per year under either organizational form. The tax rate on corporate profits is 30 percent (Tc = 0.30); the average personal tax rate for the partners is 35 percent (Tp = 0.35); and the capital gains tax rate on dividend income is 15 percent (Tdiv = 0.15). Then, recalculate the tax disadvantage using the same income but with the maximum tax rates that existed prior to 2003. (These rates were 35 percent (Tc = 0.35) on corporate profits and 38.6 percent (Tp = 0.386) on personal investment income.) ANSWER P1-2 part 1. Current (under provisions of the Tax Relief Act of 2003). If the firm is organized as a partnership, operating income will be taxed only once, so investors will
If the Partnership makes a Distribution then BOTH the Capital Account and the Tax Basis are REDUCED by the amount of the Distribution.
As a hybrid of partnerships and corporations, LLC’s provide limited liability for debts and flexibility to be taxed as a partnership or corporation (Staring and Naming a Business Presentation, 2012, Slide 5). Some specific advantages include being empowered authorities in the management of the business, diversity of members, limited liability, pass-through taxation, and less paperwork (appreciated by many). A drawback of this business structure is the need for a tailored operating agreement that specifies the specific needs of the
In its current income range LT’s tax rate is at 29%. In 2001 it was taxed at around 30% when it had more than twice the income before taxes. Therefore the current tax rate can be assumed the same for the future. Therefore the tax consequences will depend a lot on whether the investors or the company has more tax rates.
General Partnerships are not without their disadvantages. Without being an incorporated company the owners are still subject to issues such as liability, control, and location issues.
1) Section 351: Since Individual will be in control (80%+ ownership) of future corporation, he will not incur a taxable event
Whether certain allocations of partnership income, gain, loss, deductions, and credits have substantial economic effect and whether that has any impact on the partners’ distributive shares.
When it comes to partnerships Alex, Bill, Carl, and Devon will have two options- a general partnership or a limited partnership. Partnerships are beginning to be a business form of the past. Once upon a time, partnerships were “the default form of business and provided the benefit of pass-through taxation, but lacked the important feature of limited liability” (Chrisman, 2010, p. 465). In a general partnership, each partner associated with the entity will be held liable for their own business decisions as well as
No, they are not always considered separate entities when dealing with substantive liabilities and duties of the partners, the limited partnership is considered an aggregate of the individual partners.
Liability All liabilities are the responsibility of each partner. In the event of litigation, any creditors can go after the personal assets of each partner to recover any debt owed. But since liability is spread out between the owners, one may feel less risk is being taken. 2. Income Taxes General partnership may also benefit from pass-through taxation, meaning the partners are taxed like sole proprietors. Business income is reported on the personal tax filing while business losses can be deducted to reduce personal tax liability. The partnership itself is not subject to federal income tax. However the partnership needs to file an information return utilizing the IRS Form 1065. 3. Longevity or continuity of the organization Once the partnership agreement is fulfilled, the general partnership may dissolve. A buy/sell agreement may be included in the articles of the partnership to allow the
Income Taxes- Taxes are paid as income tax, unless the limited partnership is classified as a corporation by the IRS for tax purposes. In order to keep from being taxed this way, you would have to stick solely to the contract as written, and keep away from operating outside of the agreement.
Objective: Analyze the effect of changes in marginal revenues and costs on a firm’s profit-making potential.
This is typically determined by how much money each limited partner is investing in the company.
Federal tax rates on corporate taxable income vary from 15% to 35%. State and local taxes and rules vary by jurisdiction, though many are based on Federal concepts and definitions. Taxable income may differ from book income both as to timing of income and tax deductions and as to what is taxable. Corporations are also subject to a Federal Alternative Minimum Tax and alternative state taxes. Like individuals, corporations must file tax returns every year. They must make quarterly estimated tax payments. Controlled groups of corporations may file a consolidated return. Partnerships have flow-through taxation which means that the entity does not pay taxes on its income. Instead, the owners of the entity pay tax on their "distributive share" of the entity's taxable income, even if no funds are distributed by the partnership to the owners. Estates and nongrantor trusts must file income tax returns just as individuals do, but with some important differences. For one, their income is taxed at either the entity or beneficiary level depending on whether it is allocated to principal or allocated to distributable income, and whether it is distributed to the beneficiaries. And because their exemption amounts, tax brackets and related thresholds haven’t been indexed for inflation or modified for tax relief to the extent those for individuals have, they can be
c) Tax Rate: Use of a tax rate derived from the summation of state and statutory taxes instead of the firm's marginal tax rate
There are a number of forms of ownership that the business can take. The main forms are sole proprietorship, partnership, Limited Liability Corporation, corporation and S corporation. There are advantages and disadvantages to each of these forms that will be discussed in this section. A sole proprietorship essentially has the person as the business. In this situation, the proprietor bears all of the risk involved in the business. Business income flows through to the proprietor's personal taxes. For some individuals there are tax advantages, but for many the appeal of the sole proprietorship is its simplicity. The IRS defines a partnership as a relationship existing between two or more individuals who joint to carry on a business. Partners divide income according to their own agreement and that income flows through to their personal taxes. Partners also have a high level of liability for any legal action that befalls the company.