You are a shareholder in a corporation. This corporation earns $4 per share before taxes. After it has paid taxes, it will distribute the remainder of its earnings to you as a dividend. The dividend is income to you, so you will then pay taxes on these earnings. The corporate tax rate is 35% and your tax rate on dividend income is 15%. The effective tax rate on your share of the corporation's earnings is closest to:

Question

Quizplus · Accepted Answer

First, we need to calculate how much tax the corporation pays on its earnings. The earnings per share are $4, and the corporate tax rate is 35%, so the taxes paid are:

$4 x 0.35 = $1.40

This leaves $2.60 per share for distribution as a dividend.

As a shareholder, you will then pay taxes on this dividend income. The dividend is $2.60 per share and your tax rate on dividend income is 15%, so the taxes paid are:

$2.60 x 0.15 = $0.39

The effective tax rate is the total tax paid divided by the earnings before taxes:

($1.40 + $0.39) / $4 = 0.45 or 45%

Therefore, the answer is C) 45%.

You Are a Shareholder in a Corporation