Loretta plans to start a small business, operated through a corporation. In year 0, she expects the corporation to generate a loss of $100,000. Subsequently, she expects the corporation to be profitable, and projects profit of $150,000 in year 1, and $250,000 in year 2. Loretta's personal marginal tax rate on ordinary income is 35%. Using a 10% discount rate, calculate the present value of expected tax savings and costs on the business earnings for the first 3 years of operations if the business does not make an S corporation election.

Question

Quizplus · Accepted Answer

The corporation will not benefit from the year 0 loss immediately. In year 1, the corporation will pay taxes on $150,000 at the corporate tax rate (assumed to be 21%), resulting in $31,500 tax cost. In year 2, taxes on $250,000 will be $52,500. The present value of these tax costs at a 10% discount rate is approximately $73,518.

Loretta Plans to Start a Small Business, Operated Through a Corporation