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Mango, an individual, has a marginal tax rate on ordinary income of 37 percent. he currently earns $1,250,000 per year of ordinary income through a business operated as a sole proprietorship. if mango does not require current cash from the business, calculate the potential decrease in his annual tax liability if he incorporates and operates the business through a c corporation. assume the corporate tax rate is 21%.

a. $9,000
b. $63,000
c. $48,000
d. $30,000

1 Answer

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Final answer:

By incorporating and operating the business through a C corporation, Mango could decrease his annual tax liability due to the difference in tax rates. None of the multiple-choice options match the calculated potential reduction in tax liability of $200,000, suggesting a discrepancy in the provided answers or the question.

Step-by-step explanation:

When Mango, an individual, incorporates his business and chooses to operate it through a C corporation, he can potentially lower his annual tax liability due to the difference in tax rates between individual income tax and corporate tax. With his current ordinary income of $1,250,000, he is subject to a 37% marginal tax rate. If this income is earned through a C corporation, the income would be subject to the corporate tax rate of 21% instead.

Calculating the decrease in tax liability involves applying the individual marginal tax rate and the corporate tax rate to the $1,250,000 income. The individual tax liability would be 37%, amounting to $462,500. The corporate tax liability on the other hand would be 21%, amounting to $262,500.

Therefore, the potential decrease in annual tax liability when switching from individual to corporate taxation would be the difference between these two figures, which is $200,000 ($462,500 - $262,500). However, it's important to note that if Mango requires to extract profits from the corporation in the form of dividends, these would be subject to double taxation: first at the corporate level and then at the individual level when received as dividends, potentially affecting the effective savings.

Given the options provided, none of the options (a) $9,000 (b) $63,000 (c) $48,000 (d) $30,000 directly align with the calculated potential reduction of $200,000 in tax liability. It's possible the question is missing the correct option or additional context is required to match one of the provided answers.

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