Question

Mike Barton owns Barton Products, Inc. The corporation has 30 employees. Baton Corporation expects $800,000 of net income before taxes in 2018. Mike is married and files a joint return with wife, Elaine, who has no earnings of her own. Mike and Elaine have no other income, file a joint tax return, and claim the standard deduction. Mike's salary is $200,000 per year (already deducted in computing Barton Corporation's $800,000 net income).

a. Should Mike increase his salary from Barton by $50,000 to reduce the overall tax burden to himself and Barton Products? Because of the Social Security cap, the corporation and Mike each would incur a 1.45% payroll tax with the corporate portion being deductible.

b. Should Barton employ Mike's wife Elaine for $50,000 rather than increase Mike's salary? Take into consideration employment taxes as well as federal income taxes. Note that Elaine's salary would be well below the Social Security cap, so that she and the corporation each would incur the full amount of payroll taxes with the corporate portion being deductible. Both Elaine's and the corporation's portion is 7.65%.

Please identify issues and tax laws that apply like Section 351 and show how you got the answer

Answer 1

A. Should Mike increase his salary by $50,000.00 to reduce the overall tax burden to himself and Barton Products? Because of the social security cap, the corporation and Mike each would incur a 1.45% pay roll tax with the corporate portion being deductible.

Answer:

Salary is an important component that has direct impact over the profitability of the company. Increase in the salary will decrease the profit of the company and at the same time will increase the tax to Mike.

Corporation’s Current Tax Burden = $800,000 * 34% = $272,000

VAT = (($800,000 - $100,000)*5%) = $35,000

Total Tax liability on Barton Corporation = $272,000 + $35,000 = $307,000

Mike's salary per year is = $200,000

Mike’s Falls in the slab of = 151,200 to 230,450 which is having a base tax of $29,387.50 + 28% over 151,200 (Reference: https://www.putnam.com/literature/pdf/II939.pdf).

Therefore, the tax on $151,200 = $29,387.50

And the tax on the difference between $180,000 and $151,200 = ($180,000 – $151,200) *28%

                                                                                                     = $13,664

Therefore, the total tax liability of Mike = $29,387.50 + $13,664

                                                                 = $43,051.50

Incase if the Corporation has already paid to Mike, then the corporation’s tax will also get reduced by: $50,000 * 34% = $17,000.

Therefore, the amount that will be reduced from the tax for the corporation = $17,000

And, the amount that will be increased in the Mike’s Tax liability = $50,000 * 28% = $14,000

From the above calculation it is clear that increasing the salary to Mike will not be an appropriate decision as it increases the tax liability to Mike.

B. Should Barton employ Mike's wife Elaine for $50,000 rather than increase Mike's salary? Take into consideration employment taxes as well as federal income taxes. Note, that Elaine's salary would be well below the Social Security cap, so that she and the corporation each would incur the full amount of payroll taxes with the corporate portion being deductible. Both Elaine's and the corporation's portion is 7.65%

Answer:

In this case, the decision will be different from the Mike situation. Barton can provide $50,000 to Mike’s wife Elaine as it will not increase the tax liability. From Part a) it is clear that increasing salary will decrease the tax burden for Barton by $17,000. For Elaine there will be no tax burden as up to $50,000 of income there is no tax liability for an individual, therefore Elaine will not have any tax burden.

In this case, Elaine is required to file her taxes as an individual and not jointly to avail the exemption of $50,000. In this case, Elaine salary is below the social security cap and thus both the employee and employer will be liable for the entire payroll taxes but there is a deduction available for the corporate portion of amount. The corporate portion of deduction is at 7.65% therefore, the amount is $3,825 that is 7.65%*$50,000.