A taxpayer capitalizes a wholly owned corporation with $100,000. The corporation invests in a project that earns an annual pretax rate of return of 15% and faces a 15% corporate tax rate. The taxpayer...

A taxpayer capitalizes a wholly owned corporation with $100,000. The corporation invests in a project that earns an annual pretax rate of return of 15% and faces a 15% corporate tax rate. The taxpayer faces a personal tax rate of 39.6% and expects to liquidate the corporation after 20 years.

a. What is the after-tax rate of return on this investment?

b. Do you recommend that the taxpayer make this investment via an S corporation to avoid double taxation? Assume the corporation distributes enough cash to the taxpayer each year to allow him to pay his taxes on the S corporation income.

 (Exercise adapted from problem written by Richard Sansing, Dartmouth College.)