Question

3. Marlo, a publicly held corporation with a 21 percent tax rate, has agreed to pay an annual salary of $1.3 million to its employee, Mrs. Ryman. In each of the following cases, compute Marlo's after-tax cost of the salary. In making your calculations, ignore the employer payroll tax. a. Mrs. Ryman is Marlo's principal executive officer (PEO). b. Mrs. Ryman is Marlo's director of marketing and the sixth most highly compensated employee in the company.

Answer 1

A publicly held corporation is prohibited from deducting more than $ 1,000,000 per year in compensation paid to "covered employees".

Covered employee for this statement means the Principle Executive Officer or the Principle Finance Officer of the corporation and such other employees whose compensation is required to be reported to shareholders under the Securities Exchange Act 1934 by the reason that such employees are among the three highest compensated officers of the corporation in addition to the Principle Executive Officer.

Hence, the Salary of top three most highly compensated employee and the Principle Executive Officer or Principle Finance Officer cannot be allowed in excess of Rs.1,000,000.

If a Company has both Principle Executive Officer and Principle Finance Officer, the salary of the top 5( P.E.O, P.F.O and three most highly compensated officer is restricted to $ 1,000,000 per financial year.

Answers.

a. The salary of Mrs. Ryman as the principle executive officer is $ 1,300,000

Computation of after tax cost of salary for Marlo in the above mentioned situation:

Computation of Salary disallowed
Description	Amount
Salary paid to the Principle Executive Officer	$1,300,000
Maximum allowable salary deduction	$1,000,000
Salary disallowed	$300,000
Computation of after-tax cost of salary on Salary Allowed
Description	Amount
Salary Allowed	$1,000,000
Tax @ 21% on above	$210,000
After tax cost of allowable Salary	$790,000
Computation of after-tax cost of salary on Salary
Description	Amount
After tax cost of allowable Salary	$790,000
Add: Salary disallowed	$300,000
After tax cost of Salary	$1,090,000

b. As evident from the statement above,the restriction is applicable to the top 5 employees of the company,being the P.E.O, the P.F.O. and three top compensated employees.

The above mentioned restriction would not be applicable to Mrs. Ryman as she is sixth most highly compensated employee.The after tax cost of salary for Marlo would be as under:

Computation of after-tax cost of salary on Salary
Description	Amount
Salary Allowed	$1,300,000
Tax @ 21% on above	$273,000
After tax cost of salary	$1,027,000