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Problem 81 – Tax Planning Case Chapter 2:
Biko owns a snowmobile manufacturing business, and Miles owns amountain bike manufacturing business. Because each business isseasonal, their manufacturing plants are idle during theirrespective off-seasons. Biko and Miles have decided to consolidatetheir businesses as one operation. In so doing, they expect toincrease their sales by 15% and cut their costs by 30%. Biko andMiles own their businesses as sole proprietors and provide thefollowing summary of their 2014 taxable incomes:
Business income
Biko
Miles
Sales
600,000.00
450,000.00
Cost of goods sold
(400,000.00)
(300,000.00)
Other expenses
(100,000.00)
(75,000.00)
Business taxable income
100,000.00
75,000.00
Other taxable income
(net of allowable deductions)
20,000.00
35,000.00
2014 Taxable income
120,000.00
110,000.00
Biko and Miles don’t know what type of entity they should usefor their combined business. They would like to know the taximplications of forming a partnership versus a corporation. Undereither form, Biko will own 55% of the business and Miles will own45%. They each require $60,000 from the business and would like toincrease that by $5,000 per year.
Based on the information provided, do a three-year projection ofthe income of the business and the total taxes for a partnershipand for a corporation. In doing the projections, assume that afterthe initial 30% decrease in total costs, their annual costs willincrease in proportion to sales. Also, assume that theirnonbusiness taxable
income remains unchanged. Use the 2015 tax rate schedules tocompute the tax for each year of the analysis.
Hint: The first step in the analysis is to calculate the taxableincome of the business entity under the assumptions given.Partnerships are conduit entities, so the partnership is notsubject to tax on its income. Biko and Miles will include theirshare of the partnership’s income in their individual taxcalculation.
Taxable Income Computation:
Biko will be taxed on 55% of the income from the partnership;Miles will be taxed on the remaining 45% of partnership income.Because they are taxed on the partnership income, the yearly cashwithdrawals are not taxed again in the partnership entity form. Thetotal tax paid under this option is the sum of the tax Biko andMiles pay as individuals.
Biko’s Tax: (2015 Single rate schedule)
Partnership Income/Tax Calculation:
2014
2015
2016
2017
Sales
1,050,000.00
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?
(projected change)
15%
15%
15%
COGS
(700,000.00)
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?
?
(projected change)
-30%
15%
15%
Other expenses
(175,000.00)
?
?
?
(projected change)
-30%
15%
15%
Taxable income
175,000.00
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?
Biko’ share
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Miles’ Share
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Taxable Income Computation:
Biko will be taxed on 55% of the income from the partnership;Miles will be taxed on the remaining 45% of partnership income.Because they are taxed on the partnership income, the yearly cashwithdrawals are not taxed again in the partnership entity form. Thetotal tax paid under this option is the sum of the tax Biko and
Miles pay as individuals.
Biko’s Tax (2015 Single rate schedule)
2015
2016
2017
Business taxable income
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?
?
Other taxable income
20,000
20,000
20,000
Total Taxable income
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?
?
Tax
?
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?
Miles Tax (2015 Single rate schedule)
2015
2016
2017
Business taxable income
?
?
?
Other taxable income
35,000
35,000
35,000
Total Taxable income
?
?
?
Tax
?
?
?
Total tax (Biko & Miles)
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?
?
Corporation Tax Calculation:
A corporation is a taxable entity. The corporation will pay taxon its income. The withdrawals by Biko and Miles take the form ofsalaries, which are deductible by the corporation and included inBiko and Miles individual income tax calculation. The tax underthis option is the sum of the tax paid by the corporation, Biko,and Miles.
2014
2015
2016
2017
Sales
1,050,000.00
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?
?
COGS
(700,000.00)
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?
?
Other expenses
(175,000.00)
?
?
?
Salaries
–
?
?
?
Taxable income
175,000.00
?
?
?
Corporate Tax
?
?
?
?
2015
2016
2017
Biko’s Tax
?
?
?
Salary from corporation
?
?
?
Other taxable income
?
?
?
Taxable income
?
?
?
Tax
?
?
?
2015
2016
2017
Miles Tax
?
?
?
Salary from corporation
?
?
?
Other taxable income
?
?
?
Taxable income
?
?
?
Tax
?
?
?
Total Tax
?
?
?
Summary of Total Tax:
2012
2013
2014
Partnership
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Corporation
?
?
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Projected difference in total tax
?
?
?
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