Question

Rover Corporation would like to transfer excess cash to its sole shareholder, Aleshia, who is also an employee. Aleshia is in the 24% tax bracket, and Rover is subject to a 21% rate. Because Aleshia's contribution to the business is substantial, Rover believes that a $145,200 bonus in the current year is reasonable compensation and should be deductible by the corporation. However, Rover is considering paying Aleshia a $145,200 dividend because the tax rate on dividends is lower than the tax rate on compensation.
Required:
a. Regarding taxes, which would benefit Aleshia the most?
b. The $135,600 dividend because after taxes she would have $__________ from the dividend and $_______ from the bonus.
c. Regarding taxes, which would benefit Rover Corporation the most?
d. Considering the two parties together, which alternative would provide the most overall tax savings? The $135,600 bonus because when the overall effect to both the corporation and the shareholder are considered the net tax savings is $_______.

Answer 1

a. Regarding taxes, Aleshia would have the most benefit from the dividend.

b. The $145,200 dividend because after taxes she would have $116,160 from the dividend and $110,352 from the bonus.

c. Regarding taxes, which would benefit Rover Corporation the most is the bonus compensation, which is tax-deductible.

d. The $145,200 bonus would provide the most overall tax savings for the two parties because when the overall effect to both the corporation and the shareholder is considered the net tax savings is $81,312.

What are net tax savings?

Net tax savings are allowable deductions enjoyed by the corporation less the amount of taxes paid by the workers and shareholders whose incomes are taxed per the allowable deductions.

Data and Calculations:

Aleshia's tax bracket = 24%

Corporation tax rate = 21%

Proposed bonus compensation = $145,200

Proposed dividend = $145,200

Maximum dividend tax rate = 20%

Dividend received by Aleshia after tax = $116,160 ($145,200 x 1 - 20%)

Bonus received by Aleshia after tax = $110,352 ($145,200 x 1 - 24%)

Benefits to corporation (tax-deductible) = $145,200

Tax on both dividend and bonus to Aleshia = $63,888 ($29,040 +$34,848)

Net benefit to both parties = $81,312 ($145,200 - $63,888)

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