Question

Torsten owns 100% of Taupe Corporation, which had net operating

income of $420,000 and long-term capital gain of $30,000 in 2015. Torsten
has sufficient income from other sources to be in the 39.6% marginal tax bracket
without regard to the results of Taupe Corporation. The corporation makes no distributions to Torsten during the year. Ignoring the 3.8% Medicare surtax on net investment income, explain the tax treatment if Taupe Corporation is:

a. An S corporation.

b. A C corporation.

Answer 1

a. For an S corporation, Torsten will include the net operating income of $420,000 in his individual tax return, but the long-term capital gain of $30,000 will not be subject to tax at the corporate level.

b. For a C corporation, Taupe Corporation will pay corporate income tax on the net operating income of $420,000 and the long-term capital gain of $30,000. The remaining after-tax income can be distributed to Torsten as dividends, potentially subjecting him to additional taxes at the individual level.

Step-by-step explanation:

a. In the case of an S corporation, the net operating income of $420,000 is passed through to Torsten, who includes it in his individual tax return. However, the long-term capital gain of $30,000 retains its character as a capital gain and is not taxed at the corporate level. This can result in potentially lower overall taxes for Torsten.

b. If Taupe Corporation is a C corporation, it pays corporate income tax on the net operating income of $420,000 and the long-term capital gain of $30,000 at the corporate level. If the after-tax income is distributed to Torsten as dividends, he may face additional taxes at the individual level.

The total tax liability is higher in the C corporation scenario compared to the pass-through nature of an S corporation.