Week 1

Week 1

Accounting Week 1 homework
• Chapter 1: Problem 1-1
a. Calculate the tax disadvantage to organize 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 in 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% (Tc = 0.35), the average personal tax rate for the partners is also 35% (Tc=0.35), and the capital gain tax rate on dividend income is 15% (T div=0.15).
b. Now recalculate the tax disadvantage using the same income, but with the maximum tax rates that existed before 2003. (These rates were 35% (Tc=0.30) on corporate profits and 38.6% (Tp=0.386) on personal investment income)


Answer to A
If the firm is organized as a partnership, operating income will be taxed only once, so investors will receive $500,000 x (1- 0.35) =$325,000. If the firm is organized as a corporation, operating income will be taxed once at the corporate level, leaving $500,000 x (1- 0.35) = $325,000 available for disputation to investors, and then the dividends paid out will be taxed at the investors capital gain rate. This yields net disposable income of $325,000 x (1- 0.15) = $276,250. Partners thus pay a total tax rate of 35 percent on business income, while corporate shareholders pay a combined tax rate of 44.75 percent.
[1-(1-0.35)(1-0.15)] on this income, the “corporate tax wedge” in thus the difference between these two rates, or 9.75 percentage points. (44.75% -35%)


Answer to B
Before 2003. If the firm organized as a partnership, operating income will be taxed only once, so investors will receive $500,000 x (1- 0.386) = $307,000. If the firm is 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 x (1- 0.35)(1- 0.386) = $199,550. Partners thus pay a total tax rate...

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