Question

Kristen, the president and sole shareholder of Egret Corporation, has earned a salary bonus of $264,500 for the current year. Because of the lower tax rates on qualifying dividends, Kristen is considering substituting a dividend for the bonus.

Assume that the tax rates are 28% for Kristen and 34% for Egret Corporation. If an amount is zero, enter "0".

a. How much better off would Kristen be if she were paid a dividend rather than salary? If Kristen were paid a bonus, her after-tax effect would be $_____________________. If Kristen receives a dividend rather than salary, the after-tax effect would be $________________. Thus, she would be better off by receiving the ___________(Bonus/Dividend) .

b. How much better off would Egret Corporation be if it paid Kristen a salary rather than a dividend? The net after-tax cost of the bonus for Egret Corporation would be $_________________.

What amount of taxes does Egret Corporation save if the distribution is deemed a dividend?
$____________________

Therefore, Egret would be better off by paying the_________________(BONUS/DIVIDEND) .

c. If Egret Corporation were to pay Kristen a salary bonus of $343,850 instead of a $264,500 dividend, Kristen would receive $______________ after tax. The bonus would cost Egret Corporation $_____________ after tax.

d. Should the $343,850 bonus be paid or the $264,500 dividend distributed?

Both Egret Corporation and Kristen are better off with the_____________(BONUS/DIVIDEND).

Answer 1

a. If Kristen were paid a bonus, her after tax effect would be $190,440 [$264,500 bonus -(264,500 x 28%)]. If Kristen receives a dividend rather than salary, the after tax effect would be $224,825 [$264,500 dividend - (264,500 x 15%)]. Thus, she would be $34,385 better off by receiving the dividend.

b. Erget corporation can deduct the amount of salary bonus from the income. The net after tax cost of the bonus for Erget corporation would be $174,570 [$264,500-($264,500 x 34%)]. Dividend payment is non deductible, so Erget corporation will not save any taxes on that. Amount of taxes saved is $0 if the distribution deemed a dividend. Therefore, Erget would be better off by paying the Bonus.

c. If Erget Corporation were to pay Kristen a salary bonus of $343,850 instead of a $264,500 dividend, Kristen would receives $247,572 [$343850 - ($343850 x 28%)] after tax. The bonus would cost Egret corporation $226,941 [$343850 - ($343850 x 34%)] after tax.

d. Both Egret Corporation and Kristen are better off with Bonus of $343,850 rather than the dividend distribution of $264,500