Rover Corporation would like to transfer excess cash to its sole shareholder, Aleshia, who is also...

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 $135,600 bonus in the current year is reasonable compensation and should be deductible by the corporation. However, Rover is considering paying Aleshia a $135,600 dividend because the tax rate on dividends is lower than the tax rate on compensation.

Answer the following questions to determine whether Rover is correct in believing that a dividend is the better choice.

a. Regarding taxes, which would benefit Aleshia the most?
The $135,600 dividend because after taxes she would have $__________ from the dividend and $_______ from the bonus.

b. Regarding taxes, which would benefit Rover Corporation the most?
The $135,600 bonus because it would save Rover $__________ in taxes.

c. 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 $_______.

Solutions

Expert Solution

Part A

The $135,600 dividend because after taxes she would have $115260 from the dividend and $103056 from the bonus

Part B

The $135,600 bonus because it would save Rover $28476 in taxes.

Part C

The $135,600 bonus because when the overall effect to both the corporation and the shareholder are considered the net tax savings is $16272

Explanation :

Aleshia would prefer a dividend because she would have $115260 after tax [$135600 dividend – ($135600 × 15% tax rate)]. If paid a bonus, only $103056 after tax [$135600 bonus – ($135600 × 24% tax rate)] results. However, this ignores the effect of the payments on Rover Corporation. If rover paid Aleshia a deductible bonus, it would save $28476 ($135600 deduction for bonus payment x 21% tax rate) in taxes. (There is no deduction for a dividend payment.) Since Aleshia is $12204 better off with a dividend ($115260 after tax from a dividend – $103056 after tax with a bonus) and Rover is $28476 better off with a bonus, overall the two parties are $16272 better off with a bonus ($28476 benefit from bonus for Rover – $12204 benefit from a dividend for Aleshia). As Aleshia is the sole shareholder of the corporation, she is in a position to choose the bonus alternative.

ekkarill92 answered 1 year ago

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