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CFA Level I · CFA Level I Exam · Organizational Forms, Corporate Issuer Features, and Ownership

A profitable corporation pays 25% tax on earnings and then distributes all after-tax earnings as dividends. Shareholders pay 20% tax on dividends. A partnership earning the same pre-tax income of 1,000,000 passes income through to the owners, who pay 30% on it. Owners' total after-tax income is highest under the:

The partnership leaves owners better off by about 100,000. The corporation's income of 1,000,000 falls to 750,000 after 25% tax and 600,000 after 20% dividend tax, while the partnership's pass-through income falls to 700,000 after 30% tax. This reflects double taxation of corporations.

  1. Apartnership, by about 10,000 more than under the corporationCorrect
  2. Bcorporation, by about 50,000 more than under the partnership
  3. Cpartnership, by about 100,000 more than under the corporation

Explanation

Corporation: 1,000,000 × 0.75 = 750,000 after corporate tax; dividend tax 20% leaves 600,000. Partnership: 1,000,000 × 0.70 = 700,000. The partnership yields 100,000 more, so 700,000 − 600,000 = 100,000, not 10,000. Correct key is the third option.

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