Question

Marlo, a publicly held corporation with a 21 percent tax rate, has agreed to pay an annual salary of $1.32 million to its employee, Mrs. Ryman. In making your calculation, ignore the employer payroll tax.

Compute Marlo’s after-tax cost of the salary when Mrs. Ryman is Marlo's principal executive officer (PEO).

Compute Marlo’s after-tax cost of the salary when Mrs. Ryman is Marlo's Director of Marketing and the sixth most highly compensated employee in the company.

Answer 1

Internal Revenue Code §162(m) has imposed a limit of $1 million per taxable year on the deductibility by a “publicly held corporation” of remuneration paid for such year to each “covered employee.”

The definition of “covered employee” includes any employee (i) who at any time during the taxable year was the “principal executive officer” or “principal financial officer” of the corporation (or was an individual acting in such capacity); (ii) whose compensation “is required to be reported to the shareholders under the Securities Exchange Act of 1934 by reason of such employee being among the three highest compensated officers for the taxable year”

1 : Principal Executive Officer (PEO)

As Mrs. Ryman is PEO, she will be considered as covered employee and total tax deduction would be limited to $ 1 million per year.

The after tax cost of salary will be

($1,320,000 before tax compensation - $210,000 tax savings [ $1,000,000 deduction X 21%]

= $1,110,000

2 : Director of Marketing

Mrs. Ryman will not be considered as covered employee and entire salary would be allowed as deduction.

The after tax cost of salary will be

($1,320,000 before tax compensation - $277,200 tax savings [ $1,320,000 deduction X 21%]

= $1,042,800