Problem 5-50 (LO. 4, 8) Kristen, the president and sole shareholder of Egret Cor
ID: 2341626 • Letter: P
Question
Problem 5-50 (LO. 4, 8) Kristen, the president and sole shareholder of Egret Corporation, has earned a salary bonus of $30,000 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 24% for Kristen and 21% for Egret Corporation. a. How much better off would Kristen be if she were paid a dividend rather than salary? If Kristen were paid a bonus, she would receive would receive $ 22,800 after taxes. If Kristen receives a dividend rather than salary, she 25,500 after taxes. Thus, she would be better off by receiving the dividend Feedback Check My Work Closely held corporations have considerable discretion regarding their dividend policies. In the past, the double tax result provided strong motivation to avoid the payment of dividends. Instead, the incentive was to bail out corporate profits in a manner that provided tax benefits to the corporation. Thus, the question becomes this: Should the corporation or the shareholders benefit? In general, the best strategy considers the tax consequences to both parties.Explanation / Answer
Solution:
Answer 1) :
If Kristen were paid a reward, at that point the sum got levels with $22,800 after assessment [$30,000 bonus - ($30,000 * 24% expense rate)].
On the off chance that the installment is a profit, at that point the net sum would rise to $25,500 after assessment [$30,000 dividend - ($30,000 * 15% expense rate)].
Subsequently, Kristen would be $2,700 happier ($25,500 - $22,800) with thought of profit.
Answer 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 $23,700 [$30,000 bonus - $6,300 tax savings (21% 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 $6,300 [$30,000 (cost of a dividend) - $23,700 (cost of a bonus)] better off in case bonus is paid.
Answer 3):
If Erget Corporation were to pay Kristen a salary bonus of $35,000 instead of a $30,000 dividend,
Kristen would receives $26,600 [$35,000- ($35,000 x 24%)] after tax.
The bonus would cost Egret corporation $27,650 [$35,000 - ($35,000 x 21%)] after tax.