Question

Crocker and Company, Inc. had taxable income of $550,000. At the end of the year, it distributes all its after-tax earnings to Jimmy, the company's sole shareholder. Jimmy's marginal ordinary tax rate is 34 percent and his marginal tax rate on dividends is 15 percent. What is the overall tax rate on Crocker and Company's pre-tax income?

1) 9.9%
2) 15.0%
3) 35.0%
4) 43.9%
5) 66.7%

Answer 1

Option (4), The overall tax rate on Crocker and Company's pre-tax income is 43.9%, which includes a 34% corporate tax rate on $550,000 of income and a 15% dividend tax rate on the after-tax earnings distributed to the shareholder.

Step-by-step explanation:

To calculate the overall tax rate on Crocker and Company's pre-tax income when distributed to its sole shareholder, Jimmy, we need to consider both the corporate tax rate and the dividend tax rate that applies to Jimmy.

Since Crocker and Company's taxable income is $550,000, it falls well within the income range for a flat corporate tax rate of 34% according to the tax rate structure provided.

This means Crocker and Company would pay $187,000 in corporate taxes (34% of $550,000).

The after-tax earnings would thus be $363,000 ($550,000 - $187,000), which when distributed as dividends to Jimmy, would be subject to a 15% dividend tax rate.

The tax on the dividends would then be $54,450 (15% of $363,000).

The total tax paid on the pre-tax income of $550,000 is therefore the sum of corporate taxes and dividend taxes, which is $187,000 + $54,450 = $241,450.

To find the overall tax rate, we divide the total tax by the pre-tax income: $241,450/$550,000 = 0.439 or 43.9%.