Alan Weber originally started Prime Cuts, a small butcher shop, as a sole proprietorship. Then he began advertising in gift catalogs, and his company quickly grew into a large mail-order business.
Now Prime Cuts sends meat and seafood all over the world by overnight mail.
At the beginning of the current year, Weber reorganized Prime Cuts as a corporation—with himself as the sole stockholder. This year, the company earned $1 million before income taxes. (For the current year, the corporate income tax rate is 40 percent. Weber’s personal income is taxed at the rate of 45 percent. )
With respect to salaries and withdrawals of assets, Weber continued the same policies as when the business had been a sole proprietorship. Although he personally runs the business, he draws no salary. He explains, “Why should I draw a salary? Nowadays, I have plenty of income from other sources. Besides, a salary would just reduce the company’s profits—which belong to me.”
In recent years, Weber had made monthly transfers from the business bank account to his personal bank account of an amount equal to the company’s monthly net income. After Prime Cuts became a corporation, he continued making these transfers by declaring monthly dividends.
a. Without regard to income taxes, identify several reasons why it might be advantageous for Weber to have incorporated this business.
b. Compute the portion of the company’s $1 million pretax income that Weber would have retained after income taxes if Prime Cuts had remained a sole proprietorship.
c. Compute the portion of this $1 million before-tax income that Weber will retain after income taxes, given that Prime Cuts is now a corporation.
d. Explain the meaning of the term double taxation.
e. Discuss several ways that Weber legally might have reduced the overall “tax bite” on his company’s before-tax earnings.