Question:

Sarah plans to invest $1 million in a business venture that will last five years. She is debating whether to operate the business as a C corp or a sole proprietorship. If a C corp, she can liquidate the corporation at the end of the five-year period. She expects the business to prepare taxable income as follows:

year 1: 40,000, year 2: 70,000, year 3: 90,000, year 4: 150,000, year 5: 350,000.

If incurred in corporate form, these taxable income amounts will be subject to the corporate tax rate schedule. If in proprietorship form, they can be subject to Sarah's 35% marginal tax rate. Consider that any capital gain upon corporate liquidation will be taxed at a 23.8% capital gains rate (including the 3.8% net investment tax rate) and that sec. 1202 does not apply.

Required:

Evaluate the after-tax amount Sarah will have at the end of five years under each alternative. Which alternative do you recommend?