A taxpayer capitalizes a wholly owned corporation with $ 100,000. The corporation invests in a project that earns an annual pretax rate of return of 15% and faces a 15% corporate tax rate. The taxpayer faces a personal tax rate of 39.6% and expects to liquidate the corporation after 20 years.
a. What is the after tax rate of return on this investment?
b. Do you recommend that the taxpayer make this investment via an S corporation to avoid double taxation? Assume the corporation distributes enough cash to the taxpayer each year to allow him to pay his taxes on the S corporation income. (Exercise adapted from problem written by Richard Sansing, Dartmouth College.)