Tax Laws (2)
Posted on December 8, 2008 - Filed Under Finance
In addition to personal taxes paid by individuals, investor-owned (forprofit) corporations must pay both federal and state corporate taxes, which can exceed 40 percent of the corporation’s taxable income. Corporate taxes are paid on earnings before dividends are distributed, so corporate income is subject to double taxation—once at the corporate level and again when stockholders receive dividends or capital gains.
Not-for-profit corporations, for the most part, are not subject to income or property taxes. In addition, such organizations benefit from being able to issue (take on) debt with interest payments that are exempt from personal taxes. To illustrate the advantage of being able to issue tax-exempt debt, first consider the bonds issued by Jefferson Regional Medical Center (JRMC), an investor-owned hospital. Its debt carries an interest rate of 10 percent, so bond investors receive 0.10 × $100 = $10 in annual interest for every $100
worth of bonds that they own. For a bond investor that pays 40 percent in federal and state income taxes, each $10 of interest provides the investor with AT = BT × (1 ? T) = $10 × (1 ? 0.40) = $6 of after-tax interest. However, if the bonds had been issued by Riverside Memorial Hospital, a not-for-profit corporation, the investor would have to pay no taxes on the interest and hence would keep the entire $10. If investors truly require a $6 after-tax return, Riverside can issue debt with an interest rate of only 6 percent and, with all else the same, investors in the 40 percent tax bracket would be as willing to buy these bonds as they are the JRMC 10 percent bonds. Thus, the interest rate that Riverside must set on its debt issues to sell them to investors is lower than the rate that JRMC must set because of the tax exemption on debt issued by not-for-profit corporations.
Finally, contributions that individuals make to not-for-profit corporations are tax deductible to the donor. If John Brooks is in the 40 percent tax bracket and he donates $1,000 to Riverside Memorial Hospital, his taxable income would be reduced by $1,000. A reduction in taxable income of this amount would save John T × $1,000 = 0.40 × $1,000 = $400 in taxes. Thus, the effective cost of his contribution would only be $600. In effect, the government will pay John 40 cents for every dollar he contributes. Thus, not-for-profit corporations have access to a source of financing that, for all practical purposes, is not available to investor-owned businesses.
Because of the impact that taxes have on usable earnings of investorowned businesses and because not-for-profit ownership has important tax consequences, tax implications are highlighted and explained as necessary throughout the book. Still, what is most important now is to recognize that taxes will play a critical role in many topics to be discussed.
Taken From : HEALTHCARE FINANCE
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