Optimizing Your After-Tax Income in Different Business Scenarios: A 2023 Analysis

QUESTION

In 2023, Purple Company reports $200,000 in net income before deducting any compensation or other payment to its sole owner, Kirsten. Kirsten is single and she claims the $13,850 standard deduction for 2023 (she has no other deductions).

Purple Company is Kisten’s only source of income. Ignoring any employment tax consideration, compute Kirsten’s after-tax income if:

a. Purple Company is a proprietorship and Kristen withdraws $50,000 from the business during the year; Kirsten claims a $37,230 deduction for qualified business income.

b. Purple Company is a C corporation and the corporation pays out all of its after-tax income as a dividend to Kirsten.

c. Purple Company is a C corporation and the corporation pays Kirsten a salary of $158,000.

ANSWER

In 2023, Kirsten, the sole owner of Purple Company, reports a net income of $200,000 before considering any compensation or payments to herself. Kirsten is single and claims the standard deduction of $13,850 for 2023, with no other deductions. We will calculate Kirsten’s after-tax income for three different scenarios: when Purple Company is a proprietorship, a C corporation paying dividends, and a C corporation paying a salary.

Scenario A: Purple Company is a Proprietorship In this scenario, Purple Company is a sole proprietorship, and Kirsten withdraws $50,000 from the business during the year. She also claims a $37,230 deduction for qualified business income.

Kirsten’s taxable income is calculated as follows: Net Income Before Deductions: $200,000 Minus Qualified Business Income Deduction: -$37,230 Taxable Income: $200,000 – $37,230 = $162,770

Now, let’s calculate Kirsten’s federal income tax using the 2023 tax brackets for a single individual:

1. 10% on income up to $10,275: $10,275 * 0.10 = $1,027.50
2. 12% on income between $10,276 and $41,775: ($41,775 – $10,276) * 0.12 = $3,427.88
3. 22% on income between $41,776 and $89,075: ($89,075 – $41,776) * 0.22 = $10,441.98
4. 24% on income between $89,076 and $170,050: ($162,770 – $89,076) * 0.24 = $17,684.88

Total Federal Income Tax: $1,027.50 + $3,427.88 + $10,441.98 + $17,684.88 = $32,582.24

Kirsten’s after-tax income in this scenario would be her net income minus the federal income tax: After-Tax Income: $200,000 – $32,582.24 = $167,417.76

Scenario B: Purple Company is a C Corporation with Dividend Payout In this scenario, Purple Company is structured as a C corporation, and the corporation pays out all of its after-tax income as a dividend to Kirsten.

The C corporation pays corporate income tax on its net income. The corporate tax rate can vary, but let’s assume a rate of 21% for simplicity. The after-tax income available for distribution to Kirsten is:

After-Tax Income: $200,000 * (1 – 0.21) = $158,000

Since dividends received by individuals are typically taxed at a lower rate than ordinary income, Kirsten will pay taxes on the dividend income. In 2023, qualified dividend income is taxed at rates of 0%, 15%, or 20%, depending on Kirsten’s overall taxable income.

Let’s assume Kirsten falls into the 15% tax bracket for qualified dividends. Her tax on the dividend income would be:

Tax on Dividend Income: $158,000 * 0.15 = $23,700

Kirsten’s after-tax income in this scenario would be the dividend income minus the tax on dividends: After-Tax Income: $158,000 – $23,700 = $134,300

Scenario C: Purple Company is a C Corporation with Salary In this scenario, Purple Company is a C corporation, and the corporation pays Kirsten a salary of $158,000.

Kirsten’s taxable income in this scenario is her salary: Taxable Income: $158,000

Now, let’s calculate Kirsten’s federal income tax based on her taxable income and the 2023 tax brackets for a single individual:

1. 10% on income up to $10,275: $10,275 * 0.10 = $1,027.50
2. 12% on income between $10,276 and $41,775: ($41,775 – $10,276) * 0.12 = $3,427.88
3. 22% on income between $41,776 and $89,075: ($89,075 – $41,776) * 0.22 = $10,441.98
4. 24% on income between $89,076 and $162,000: ($158,000 – $89,076) * 0.24 = $16,581.36

Total Federal Income Tax: $1,027.50 + $3,427.88 + $10,441.98 + $16,581.36 = $31,478.72

Kirsten’s after-tax income in this scenario would be her salary minus the federal income tax: After-Tax Income: $158,000 – $31,478.72 = $126,521.28

In conclusion, Kirsten’s after-tax income varies depending on the business structure and compensation method:

a. In the proprietorship scenario, her after-tax income is $167,417.76. b. In the C corporation with dividend payout scenario, her after-tax income is $134,300. c. In the C corporation with salary scenario, her after-tax income is $126,521.28.