Mr. Young operates a photography studio as a sole proprietorship. His average annual income from the business is $100,000. Because Mr. Young does not need the entire cash flow for personal consumption, he is considering incorporating the business. He will work as a corporate employee for a $40,000 annual salary, and the corporation will accumulate its after-tax income to fund future business expansion. For purposes of this case, assume that Mr. Young’s marginal income tax rate is 33 percent and ignore any employment tax consequences.
a. Assuming that the new corporation would not be a personal service corporation, would Mr. Young decrease the annual tax burden on the business by incorporating?
b. How would your answer change if the new corporation would be a personal service corporation?