The owner of Web City is trying to decide whether to remain a proprietorship or to incorporate. Suppose that the corporate tax rate on profits is 20 percent and the personal income tax rate is 30 percent. For simplicity, assume that all corporate profits (after corporate taxes are paid) are distributed as dividends in the year they are earned and that such dividends are subject to tax at the personal income tax rate.

a. If the owner of Web City expects to earn $100,000 in before-tax profits this year, regardless of whether the firm is a proprietorship or a corporation, which method of organization should be chosen?

b. What is the dollar value of the after-tax advantage of the form of organization determined in part (a)?

c. Suppose that the corporate form of organization has cost advantages that will raise before-tax profits by $50,000. Should the owner of Web City incorporate?

d. Based on parts (a) and (c), by how much will after-tax profits change due to incorporation?

e. Suppose that tax policy is changed to completely exempt from personal taxation the first $40,000 per year in dividends. Would this change in policy affect the decision made in part (a)?

f. How can you explain the fact that even though corporate profits are subject to double taxation, most business in the United States is conducted by corporations rather than by proprietorships or partnerships?