Richard plans to invest $100,000 for a 50 percent interest in a small business. His friend Jack will also invest $100,000 for the remaining 50 percent interest. On their investment, they expect to generate 10 percent before-tax return the first year. Richard's marginal tax rate is 33 percent, and Jack's marginal tax rate is 35 percent. They need to decide whether to establish the business as a partnership or as a C corporation.
Question 1. If they establish a partnership, compute the after-tax cash flow for each partner if each of them withdraws $4,000 from the profits of the business the first year. What is the amount of cash that remains in the partnership, exclusive of employment taxes.
Question 2. If they establish a C corporation, compute the after-tax cash flow for each shareholder if each of them receives a dividend of $4,000 from the profits of the business the first year. What is the amount of cash that remains in the C corporation?
Question 3. What nontax factors should Richard and Jack consider when making this decision?
Question 4. After a detailed analysis, what would you recommend? Do you feel Richard and Jack should establish a partnership or a C corporation?