Biko owns a snowmobile manufacturing business

jagguarpaw January 13, 2017 0 Comments

Question: Biko owns a snowmobile manufacturing business

Problem 81 – Tax Planning Case Chapter 2:

Biko owns a snowmobile manufacturing business, and Miles owns a mountain bike manufacturing business. Because each business is seasonal, their manufacturing plants are idle during their respective off-seasons. Biko and Miles have decided to consolidate their businesses as one operation. In so doing, they expect to increase their sales by 15% and cut their costs by 30%. Biko and Miles own their businesses as sole proprietors and provide the following summary of their 2014 taxable incomes:

Business income Biko Miles
Sales     600,000.00        450,000.00
Cost of goods sold (400,000.00) (300,000.00)
Other expenses (100,000.00)     (75,000.00)
Business taxable income     100,000.00        75,000.00
Other taxable income
(net of allowable deductions)        20,000.00        35,000.00
2014 Taxable income     120,000.00     110,000.00

Biko and Miles don’t know what type of entity they should use for their combined business. They would like to know the tax implications of forming a partnership versus a corporation. Under either form, Biko will own 55% of the business and Miles will own 45%. They each require $60,000 from the business and would like to increase that by $5,000 per year.

Based on the information provided, do a three-year projection of the income of the business and the total taxes for a partnership and for a corporation. In doing the projections, assume that after the initial 30% decrease in total costs, their annual costs will increase in proportion to sales. Also, assume that their nonbusiness taxable

Income remains unchanged. Use the 2015 tax rate schedules to compute the tax for each year of the analysis.

Hint: The first step in the analysis is to calculate the taxable income of the business entity under the assumptions given. Partnerships are conduit entities, so the partnership is not subject to tax on its income. Biko and Miles will include their share of the partnership’s income in their individual tax calculation.

Taxable Income Computation:

Biko will be taxed on 55% of the income from the partnership; Miles will be taxed on the remaining 45% of partnership income. Because they are taxed on the partnership income, the yearly cash withdrawals are not taxed again in the partnership entity form. The total tax paid under this option is the sum of the tax Biko and Miles pay as individuals.

Biko’s Tax: (2015 Single rate schedule)

2015 2016 2017
Business taxable income          327,250.00        376,337.50        432,788.13
Other taxable income                  20,000                20,000                20,000
Total Taxable income          347,250.00        396,337.50        452,788.13
Tax            98,198.75        114,397.63        135,673.10
Miles Tax (2015 Single rate schedule)
2015 2016 2017
Business taxable income          267,750.00        307,912.50        354,099.38
Other taxable income            35,000.00          35,000.00          35,000.00
Total Taxable income          302,750.00        342,912.50        389,099.38
Tax            83,513.75          96,767.21        112,008.92
Total tax (Biko & Miles)          181,712.50        211,164.84        247,682.02

Corporation Tax Calculation:

A corporation is a taxable entity. The corporation will pay tax on its income. The withdrawals by Biko and Miles take the form of salaries, which are deductible by the corporation and included in Biko and Miles individual income tax calculation. The tax under this option is the sum of the tax paid by the corporation, Biko, and Miles.

2014 2015 2016 2017
Sales     1,050,000.00 1,207,500.00 1,388,625.00 1,596,918.75
COGS      (700,000.00) (490,000.00) (563,500.00) (648,025.00)
Other expenses      (175,000.00) (122,500.00) (140,875.00) (162,006.25)
Salaries                          – ? ? ?
Taxable income        175,000.00 ? ? ?
Corporate Tax ? ? ? ?
2015 2016 2017
Biko’s Tax ? ? ?
Salary from corporation ? ? ?
Other taxable income ? ? ?
Taxable income ? ? ?
Tax ? ? ?
2015 2016 2017
Miles Tax ? ? ?
Salary from corporation ? ? ?
Other taxable income ? ? ?
Taxable income ? ? ?
Tax ? ? ?
Total Tax ? ? ?
Summary of Total Tax: 2012 2013 2014
Partnership ? ? ?
Corporation ? ? ?
Projected difference in total tax ? ? ?