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Rob's 2700 Notes

✏️ Two types of corporate taxation

C Corporation

Section titled “C Corporation”

✏️ You are a shareholder in a C corporation. The corporation earns $5 per share before taxes. After it has paid taxes, it will distribute the rest of its earnings to you as a dividend (we make this simplifying assumption, but should note that most corporations retain some of their earnings for reinvestment). The dividend is income to you, so you will then pay taxes on these earnings. The corporate tax rate is 40% and your tax rate on dividend income is 15%. How much of the earnings remains after all taxes are paid?

✔ Information we are given:

  • Pre-Tax Income for the corporation = $5
  • TC = Corp tax = 40%
  • TP = Personal Div Tax = 15%

Two ways to approach taxes: on the left, we calculate the after tax profit by calculating the taxes and subtracting that from the EBT. On the right, we employ a shortcut to calculate the after tax profit by multiplying the pre-tax income by 1 minus the tax rate. In general, the method on the right is more efficient.

1.) After tax profit for the firm:
Net Income = PreTaxIncome - PreTaxIncome * TC
= $5 - $5*40% = $3.00
2.) After tax profit for the firm:
Net Income = Pretax Income * (1-Tc)
= $5 * (1-40%)
= $5 * (60%) = $3.00

Next, we need to calculate the after tax income for the investor. We’ll use the same shortcut for this (method 2: multiplying by (1-T))
After tax income for the investor = Dividend × (1-TP).
= $3 * (1-15%) = $2.55

After double taxation, only $2.55 remains for the investor. Almost half of the money was taken.

S Corporation

Section titled “S Corporation”

✏️ Rework the previous example assuming the corporation in that example has elected subchapter S treatment and your tax rate on non-dividend income is 30%.

✔ Now we redo the problem assuming a tax rate of 30% on non-dividend income.

Two ways to approach taxes: (we will use the second)

1.) After tax profit for the firm:
Net Income = PreTaxIncome - PreTaxIncome * TC
= $5 - $5*30% = $3.5

2.) After tax profit for the firm
Net Income = Pretax Income * (1-Tc)
= $5 * (1-30%)
= $5 * (70%) = $3.5