In the U.S., you would use the formula: (corporate tax rate) + (1 - corporate tax rate)(individual tax rate) To me, this means that each dollar is taxed first at the corporate rate of 35% then at the dividend rate of 15%. So I have two questions. 1. Why do you multiply the indivudual rate by (1-corp tax rate)? I interpret this as meaning that after paying 35% tax on that 1 dollar, you multiply the leftover amount (i.e. amount not taxed at the corporate level) by the individual tax rate–but does this make sense or is this even correct? 2. Is the corporation really being double taxed, or just that one dollar of earnings? To me, it looks like the corporation is paying 35% and the individual investor is paying the 15%, so am I correct to assume that the corporation is only taxed once, and the individual once–and that one dolalr of earnings is taxed twice? Thanks.
- Yes 2. Yes
elaborat please? Q1 asked why you multiply by the 1-corp tax and Q2 asked if the corp or just the earnings are taxed twice. thanks.
individuals are only taxed on the portion they receive, which is the 1-corp tax rate. Then they pay tax. so the effective tax is the corporate tax paid + the tax paid by the individual. The corporation is taxed once, then the individual is taxed once. Think of it like this: you earn a couple bucks at company XYZ, and you pay tax on the earnings. Then, after those taxes you kick out a dividend to a shareholder. That shareholder then pays tax on the dividend(if in taxable acct).
Corporation is taxed once. Investor is taxed once. The dollar of earnings that is transfered as a dividend is taxed twice.
Maybe an example would help. Assume this scenario… EBT:________$30 Tax @ 40%:__-$12 Inc for Divs:__$18 If the personal income tax rate is 36%… Tax @ 36%:__-$6.48 The after-tax income to dividend recipients is then 18 - 6.48 = $11.52. So, * Total taxes paid are 12 + 6.48 = 18.48, and * Taxable income is $30 * Effective tax rate = 18.48/30 = 61.6% Your formula gives you the same answer: 0.4 + (1 - 0.4)(.36) = .616 The example above may be a bit more intuitive because you just apply taxes to income where taxable, add all the taxes up, then divide by corporate taxable income. But I think your formula makes sense as well because it is essentially a weighted tax burden: (100% of income x 40% rate) + ((100% income - 40%) x 36% rate), where income is the weight. If you had yet another point of taxation, you would add a third term such that, (100% of income x 40% rate) + ((100% income - 40%) x 36% rate) + [[100% income - 40% - ((100% income - 40%) x 36% rate)] x Y% rate] Hopefully that does more to clarify than confuse.
tvPM Wrote: ------------------------------------------------------- > individuals are only taxed on the portion they > receive, which is the 1-corp tax rate. Then they > pay tax. so the effective tax is the corporate tax > paid + the tax paid by the individual. for this to be true, the problem would have to say that the corporation pays out 100% of its earnigns as dividends right? that would make sense, becuaes if the corp made 1 dollar, it paid 35 cents corporate tax, leaving 65 cents of net profit to go all to investor, which gets taxed at 15%. im confused because i remember a problem from qbank where the corporation only paid out 30% of its earnings as dividends but the formula was the same.
CF_AHHHHHHHHH Wrote: ------------------------------------------------------- > Corporation is taxed once. Investor is taxed > once. The dollar of earnings that is transfered > as a dividend is taxed twice. Exactly what i was thinking. First the corporation then the investor. I had always remember hearing that corporations get double taxed when in fact they don’t–just the income that is paid as dividend gets taxed twice. But corps pay one tax and investors pay the other.