Shelley is the sole shareholder and president of Zeth Corporation (a C corporati

Question

Shelley is the sole shareholder and president of Zeth Corporation (a C corporation). She feels she is entitled to a $220,000 bonus this year because of her performance. However, rather than a bonus in the form of a salary, she plans to have Zeth pay her a $220,000 dividend. Because Shelley’s marginal tax rate is 35%, she prefers to receive a dividend taxed at 15%. Her accountant, suggests a $310,000 bonus in lieu of the $220,000 dividend since Zeth Corporation is in the 34% tax bracket. Should Shelley take the $220,000 dividend or the $310,000 bonus? Support your answer by computing the after-tax cost of the two alternatives to Zeth and to Shelley. What if Zeth were an S corporation? How would your answer change?

Explanation / Answer

Shelley should choose the $310,000 bonus instead of $220,000 dividend because the after tax benefit to her is greater and the after tax cost of Zeth corporation is less. Shelley's after tax benefit for teh bonus is $201,500($310,000 X(1-.035), While her after tax benefit for the dividend is $187,000[220,000X (1-0.15)] .Zeth corporation after tax cost for teh bonus is $204,600[$310,000-($310,000 X 0.34)] tax saved ,while its after tax cost for teh dividend is $ 220,000-the dividend is not deductable.

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