Question

plum corporation will begin operations on january 1. earnings for the next five years are projected to be relatively stable at about $80,000 per year. the shareholders of plum are in the 32% tax bracket. evaluate whether plum should operate as a c corporation or as an s corporation given the following assumptions: a) plum will reinvest its after-tax earnings in the growth of the company for the foreseeable future. b) plum will distribute its after-tax earnings each year to its shareholders.

Answer 1

For Plum Corporation, the choice between a C corporation and an S corporation depends on their strategy for after-tax earnings. A C corporation allows for reinvestment without immediate personal taxation, whereas an S corporation avoids double taxation on distributed earnings.

Step-by-step explanation:

The question is evaluating whether Plum Corporation should operate as a C corporation or an S corporation. When deciding on the corporate structure, it is crucial to consider how the business plans to manage its earnings, particularly regarding reinvestment or distribution of after-tax earnings. With stable projected earnings of $80,000 per year and a tax bracket of 32% for the shareholders, the decision rests on the implications of corporate and personal taxation levels.

A C corporation is taxed separately from its owners, and profits can be reinvested in the company after corporate taxes are paid. If the profits are distributed as dividends, they could be subject to double taxation at the corporate level and then again at the personal level. In contrast, an S corporation's profits pass through directly to the shareholders' personal tax returns, avoiding double taxation. Under the provided scenario:

• If Plum Corporation decides to reinvest its after-tax earnings back into the company (Scenario A), it might prefer to choose a C corporation status to benefit from corporate reinvestment without immediacy of personal taxes on those reinvested earnings.
• If Plum Corporation opts to distribute its earnings to shareholders (Scenario B), becoming an S corporation could be more advantageous to prevent double taxation, since earnings would be taxed at the shareholders' personal tax rates, and dividends would not incur additional corporate taxes.