Question

Charleston Corporation (CC) now operates as a "regular" corporation, but

it is considering a switch to S Corporation status. CC is owned by five
stockholders who each hold 20% of the stock, and each faces a personal
tax rate of 35%. The firm earns $2,000,000 per year before taxes, and
since it has no need for retained earnings, it pays out all of its
earnings as dividends. Assume that the corporate tax rate is 34% and the
personal tax rate is 35%. How much more (or less) spendable income would
each stockholder have if the firm elected S Corporation status?
a. $86,632
b. $88,400
c. $90,168
d. $91,971
e. $93,811

Answer 1

If the firm switches to S Corporation status, each stockholder would have 34% more spendable income compared to operating as a regular corporation.

Step-by-step explanation:

To determine how much more spendable income each stockholder would have if the firm elected S Corporation status, we need to compare the tax implications of operating as a regular corporation versus an S Corporation. As a regular corporation, the firm will pay corporate income tax at a rate of 34% on its earnings before distributing dividends to stockholders. The stockholders will then pay personal income tax at a rate of 35% on the dividends they receive. In this scenario, the total tax burden would be 34% + 35% = 69%.

If the firm switches to S Corporation status, it will not pay corporate income tax. Instead, the earnings will pass through to the stockholders, and they will pay personal income tax at a rate of 35% on their share of the earnings. In this scenario, the total tax burden would be 35%.

To calculate the difference in spendable income, we subtract the total tax burden of operating as an S Corporation (35%) from the total tax burden of operating as a regular corporation (69%): 69% - 35% = 34%.

Therefore, each stockholder would have 34% more spendable income if the firm elected S Corporation status.