Jerry and Matt decide to form a business. Jerry will contribute $4,200 for a 35% interest and Matt will contribute $7,800 for a 65% interest. The business will take out a $25,000 loan to cover the balance of their working capital needs. They expect that the business will have a loss of $38,000 for the first year. In the second year, the business will have a profit of $52,000 and it will distribute $5,200 to Matt and $2,800 to Jerry. Jerry is in the 32% marginal tax bracket and Matt is in the 24% marginal tax bracket. Their marginal tax brackets will not change as a result of profit or loss from this business. How much tax will Matt pay in the second year (rounded to the nearest dollar) due to this business if they organize the business as an S corporation?
A) $10,920
B) $9,464
C) $4,056
D) $3,276
E) $1,456

Question

Quizplus · Accepted Answer

Matt's share of the profit is 65% of $52,000, which is $33,800. His tax liability is 24% of $33,800, which equals $8,112. However, since S corporations pass income to shareholders, the distribution does not affect the tax calculation. Therefore, Matt's tax is $8,112.

Jerry and Matt Decide to Form a Business