LO.4,8 Kristen, the president and sole shareholder of Egret Corporation, has ear
ID: 2603009 • Letter: L
Question
LO.4,8 Kristen, the president and sole shareholder of Egret Corporation, has earned a salary bonus of $30,000 for the currei 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. a. How much better off would Kristen be if she were paid a dividend rather than b. How much better off c. If Egret Corporation pays Kristen a salary bonus of $40,000 instead of a $30,000 d. What should Kristen do? salary? rather than a dividend? dividend, how would your answers to (a) and (b) change? would Egret Corporation be if it paid Kristen a salaryExplanation / Answer
ANSWER:
1) If Kristen were paid a bonus, then the amount received equals $21,600 after tax [$30,000 bonus - ($30,000 * 28% tax rate)]. In case the payment is a dividend, then the net amount would equal $25,500 after tax [$30,000 dividend - ($30,000 * 15% tax rate)]. Hence, Kristen would be $3,900 better off ($25,500 - $21,600) with consideration of dividend
2) If Egret Corporation makes a payment to Kristen a $30,000 bonus, and then obtains a deduction for the payment. Because it decreases the Egret’s tax liability, the net after-tax cost of the bonus equals $19,800 [$30,000 bonus - $10,200 tax savings (34% tax rate *$30,000)]. On contrary, a dividend payment will not be deductible, thus no taxes would be saved by Egret. The cost of the dividend equals $30,000. Hence, Egret will be $10,200 [$30,000 (cost of a dividend) - $19,800 (cost of a bonus)] better off in case bonus is paid.
3) If Egret makes a payment to Kristen a $40,000 bonus, then Egret will receive $28,800 after tax [$40,000 bonus - ($40,000 * 28% tax rate)]. The option is preferable than receiving a $30,000 dividend, that gives $25,500 after tax. A $40,000 bonus costs Egret Corporation $26,400 after tax computed as [$40,000 bonus - (34% tax rate * $40,000)] and is less costlier than a non-deductible $30,000 dividend
4) Because both Egret Corporation and Kristen are better off with a payment of $40,000 bonus in comparison to $30,000 dividend, thus corporation should pay a bonus
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