Multiyear Tax Cases Susan Owns A Snowmobile Manufacturing Bu

Multiyear Tax Casesusan Owns A Snowmobile Manufacturing Business And

Susan owns a snowmobile manufacturing business, and Bruce owns a mountain bike manufacturing business. Because each business is seasonal, their manufacturing plants are idle during their respective off-seasons. Susan and Bruce have decided to consolidate their businesses as one operation. In so doing, they expect to increase their sales by 15% annually and cut their costs initially by 30%. Susan and Bruce own their businesses as sole proprietors and provide the following summary of their 2011 taxable incomes: Susan Bruce Business income Sales $600,000 $450,000 Cost of goods sold (400,000) (assumed as part of the data) Other expenses (100,000) (assumed as part of the data) Business taxable income $100,000 $75,000 Other taxable income (net of allowable deductions) $20,000 taxable income $120,000 $110,000 Susan and Bruce don’t know what type of entity they should use for their combined business. They would like to know the tax implications of forming a partnership versus a corporation. Under either form, Susan will own 55% of the business and Bruce will own 45%. They each require $70,000 from the business initially and would like to increase that by $6,000 per year. Based on the information provided, do a three-year projection of the income of the business and the total taxes for a partnership and for a corporation. In doing the projections, assume that after the initial 30% decrease in total costs, their annual costs will increase in proportion to sales. Also, assume that their nonbusiness taxable income remains unchanged. Use the 2011 tax rate schedules to compute the tax for each year of the analysis.

Paper For Above instruction

The decision between forming a partnership or a corporation for a consolidated business involves various tax implications that affect the net income and tax liabilities of the owners. This analysis projects the financial outcomes over three years, considering growth in sales, cost changes, and distributions, guided by the 2011 tax rate schedules.

Introduction

Choosing the appropriate business structure is crucial for maximizing after-tax income and minimizing tax liabilities. Partnerships and corporations differ notably in taxation, ownership rights, liability, and profit distribution. This paper examines the tax implications of each structure for Susan and Bruce, who are consolidating their seasonal manufacturing businesses to expand operations, increase sales, and reduce costs initially.

Initial Financial Context and Assumptions

In 2011, Susan reported a taxable income of $120,000, with sales of $600,000 and business expenses totaling $500,000. Bruce's taxable income was $110,000, with sales of $450,000 and expenses amounting to $375,000. Both are seeking to expand their business through consolidation, anticipating 15% annual sales growth, a 30% initial cost reduction, and increasing distributions by $6,000 annually.

The projection assumes that post-initial reduction, costs will increase proportionally with sales, which grow by 15% each year. Nonbusiness taxable income remains constant at $20,000 for Susan and remains in the mix for overall tax calculation.

Projected Financials over Three Years

Sales and Expenses Growth

Starting with year 1, sales increase by 15%, and costs decrease by 30%, then adjust proportionally with sales annually. This results in a pattern where expenses and sales grow together, influencing taxable income.

Year 1 Calculations

• Sales:
  • Susan: $600,000 × 1.15 = $690,000
  • Bruce: $450,000 × 1.15 = $517,500
• Total combined sales: $690,000 + $517,500 = $1,207,500
• Initial combined expenses: $500,000 + $375,000 = $875,000
• Cost reduction of 30% applies to total expenses: $875,000 × 0.70 = $612,500
• Expenses increase proportionally with sales for Year 2 and Year 3, starting with $612,500.

Year 2 Calculations

• Sales:
  • Susan: $690,000 × 1.15 = $793,500
  • Bruce: $517,500 × 1.15 = $595,125
• Total combined sales: $793,500 + $595,125 = $1,388,625
• Expenses:
  • Year 1 expenses: $612,500
  • Increase proportionally with sales: $612,500 × 1.15 = $704,375

Year 3 Calculations

• Sales:
  • Susan: $793,500 × 1.15 = $912,525
  • Bruce: $595,125 × 1.15 = $684,393.75
• Total combined sales: $912,525 + $684,393.75 = $1,596,918.75
• Expenses:
  • Year 2 expenses: $704,375
  • Increase proportionally with sales: $704,375 × 1.15 = $809,031.25

This pattern shows consistent growth in sales and expenses, affecting taxable income and subsequent tax liabilities.

Tax Computation Under Partnership and Corporation Structures

Partnership Structure

In a partnership, income passes through to owners based on their ownership percentages, with Susan owning 55% and Bruce 45%. Tax is paid individually at their applicable rates, with distributions made according to ownership shares.

For year 1, taxable income is calculated as the net profit after expenses, then allocated accordingly. Similar calculations are performed for years 2 and 3.

Year 1 Partnership Income

• Net income: Total sales minus expenses: $1,207,500 - $612,500 = $595,000
• Individual shares:
  • Susan: $595,000 × 0.55 = $327,250
  • Bruce: $595,000 × 0.45 = $267,750

Adding their other taxable income ($20,000 for Susan), taxable incomes are:

• Susan: $327,250 + $20,000 = $347,250
• Bruce: $267,750

Using the 2011 progressive tax rate schedules, calculate individual taxes and sum them for total partnership tax liabilities.

Year 2 and 3 Calculations

Repeat similar steps, adjusting income according to projected sales and expenses, and applying the individual tax rate schedule annually.

Corporate Structure

If organized as a corporation, the business pays corporate income tax on profits. The remaining after-tax income can be distributed to shareholders as dividends, potentially taxed again at individual rates. The corporation's taxable income is equivalent to net profit; the corporate rate applies to this profit.

Calculating corporate tax involves applying the 2011 flat corporate rate of 35% on the projected profits. After-tax profits are then available for dividends, which are taxed again at individual rates, with a qualified dividend tax rate of 15% applicable.

Year 1 Corporate Tax

• Taxable profit: $595,000
• Corporate tax: $595,000 × 0.35 = $208,250
• After-tax income: $595,000 - $208,250 = $386,750

Dividends paid to owners are proportionate to ownership, taxed at dividend rates.

Year 2 and 3 Corporate Taxes

Apply similar calculations for subsequent years, updating profits based on growth projections.

Comparison and Conclusion

The analysis indicates that, in the initial years, a partnership may result in higher individual tax liabilities due to pass-through taxation, but avoids corporate double taxation. Conversely, forming a corporation provides liability protection and potential tax deferral but entails corporate taxes and dividend taxation. The choice depends on factors such as liability concerns, profit reinvestment plans, and long-term growth strategies.

References

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