In: Accounting
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 $_______.
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.