Charleston Corporation (CC) now operates as a \"regular\" corporation, but it is
ID: 2655164 • Letter: C
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?
Explanation / Answer
Answer is $88,400
Before S Coproration status total profit after tax in case of regular corporation = $2,000,000 * (1 - 0.34) * (1 - 0.35) = $858,000. This is because in case of regular corporation, income is taxed at corporate level at corporate tax rate and further if post-tax income is distributed to shareholders then it is again taxed at personal tax rate. Hence total income in case of regular corporation attributable to five shareholders is $858,000
In case of S Corporation, income is passed on to shareholders with any tax incidence at corporate level and it is taxed only once in the hands of individual shareholders at personal tax rate. Hence in case of S Corporation, post-tax return to five shareholders together is $2,000,000 * (1 - 0.65) = $1,300,000.
Hence, the increase in total income in hands of five shareholders is $1,300,000 - $858,000 = $442,000
Beign equal shareholders, income for each shareholder will increase by $442,000 / 5 = $88,400.