Suppose you are advising a college basketball coach on whether to organize his summer basketball camps for high school students as a C corporation versus an S corporation. The taxpayer plans to operate the camps for 5 years, then wind up the corporation by simply paying any retained earnings as a dividend in the final year. The taxpayer faces a marginal tax rate of 35% and the corporate tax rate is a flat rate of 35%. The expected pretax rate of return on the camps is 12% per year (before any compensation or dividends to the taxpayer).
a. Assuming zero dividends are paid each year, which corporate form would you advise the taxpayer to select?
b. Assuming 50% of taxable income is distributed each year as dividends, which form would you advise the taxpayer to select? Explain your answer in words (no algebra is required here).
c. Again assuming a zero dividend payout each year, what shareholder level tax rate, ts, in the C corporation form would equate the after tax return to the taxpayer in both corporate forms?
d. Explain, in words, how it might be possible to lower the shareholder level tax to the required rate in part (c) such that the after tax rate of return to the taxpayer is the same in both corporate forms.