A Public Corporation Earns $500,000 in Pre-Tax Profits and Pays

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The Answer is A)

\begin{array}{|l|r|r|}\hline ext { 1) Corporation } & & \\hline ext { Corporate income } & & \$ 500,000 \\hline ext { Less Tax } & 27.50 \% & \$ 137,500 \\hline ext { Net earnings available for dividend } & & \$ 362,500 \\hline ext { 2) Shareholder } & & \\hline ext { Taxable dividend }(\$ 362,500 imes 1.38) & & \$ 500,250 \\hline ext { Tax } & 50 \% & \$ 250,125 \\hline ext { Less dividend tax credit } & 27.50 \% & \\hline(\$ 500,250 imes .275) & & -\$ 137,569 \\hline ext { Net personal tax } & & \$ 112,556 \\hline ext { Total tax on corporate profits: } & & \\hline ext { 1. Paid by corporation } & & \$ 137,500 \\hline ext { 2. Paid by shareholder } & & \$ 112,556 \\hline & & \$ 250,056 \\hline\end{array}

B) (Note: This concept is explained at greater length in Chapter 11.)
The total tax paid by the corporation and the shareholder on the corporate profits of $500,000 is $250,056 which is roughly equal to 50% of $500,000. The shareholder is in a 50% tax bracket and would have paid $250,000 in tax if the profits had been received directly ($500,000 × 50%). Therefore, the total tax paid by the two entities is virtually the same due to the optimal combination of the corporate tax rate, the gross-up rate, and the dividend tax credit.

A Public Corporation Earns $500,000 in Pre-Tax Profits and Pays

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