Mr. Allen, whose marginal tax rate is 35%, owns an office building that generates $100,000 annual taxable income. He plans to create a family partnership by giving each of his three children a 15% interest in the building. Mr. Allen will retain a 55% interest. Mr. Allen will manage the building, and receive a guaranteed payment of $20,000. If Mr. Allen's children are in the 15% tax bracket, compute the annual tax savings from this income-shifting arrangement.

Question

Quizplus · Accepted Answer

By giving each of his children a 15% interest in the building, Mr. Allen is shifting $45,000 ($100,000 x 45%) of the building's income to his children's lower tax bracket. This results in a tax savings of $7,200 [(45,000 x 20%) - (45,000 x 15%)]. The $20,000 guaranteed payment to Mr. Allen is not affected by this income-shifting arrangement, and he will continue to pay taxes on it at his marginal rate of 35%. Therefore, the total tax savings from this arrangement is $7,200.

Mr Allen, Whose Marginal Tax Rate Is 35%, Owns an Office