Question

Information: two typical bonus plans have the following characteristics (both of which require the corporation to calculate the bonus before it determines the income tax.

1.      Bonus is based on Net Income (income statement definition) before taking the bonus

2.      Bonus is based on Net income after deducting bonus and income taxes

FACTS: ABC Corp has net income of $260,000 before deducting the bonus and before any income tax expense. The tax rate is 30%. The bonus rate is 8%.

To do:

1.      Calculate the bonus and income tax if the bonus is computed on income after deducting income taxes, but before deducting the bonus.

2.      Calculate the bonus and income tax if the bonus is computed on net income after deducting both income taxes and the bonus. This one requires modification to the formula to include the tax deduction before calculating the bonus.

Answer 1

1.

In this case the income tax amount should be calculated first; then such amount should be deducted from the net income to get the net income after tax; lastly, the amount of bonus should be calculated on such net income after tax.

Income tax amount = Net income × Income tax rate

                                = $260,000 × 30%

                                = $78,000 (Answer)

Net income after tax = Net income – Income tax amount

                                  = $260,000 - $78,000

                                  = $182,000

Bonus = Net income after tax × Bonus rate

            = $182,000 × 8%

            = $14,560 (Answer)

2.

In this case the income amount is calculated similar to as above;

Income tax amount = Net income × Income tax rate

                                = $260,000 × 30%

                                = $78,000 (Answer)

Net income after tax = Net income – Income tax amount

                                  = $260,000 - $78,000

                                  = $182,000

Now the bonus, 8%, means (8 / 100 =) 0.08. Since bonus is included in the net income after tax, it should be equal to (1 + 0.08 =) 1.08. Therefore, the bonus amount should be calculated as below:

Bonus = Net income after tax × (0.08 / 1.08)

            = $182,000 × (0.08 / 1.08)

            = $13,481.48 (Answer)