Question

Larissa is the sole owner of Theo Corp., which provides her only source of income. Larissa has always paid herself entirely by drawing dividends from her corporation. Leslie suggested that as long as Larissa is earning about what she would have to pay someone else to run the business, she might be better off paying herself a salary instead of dividends, because she would avoid the problem of double taxation. If Theo Corp. earns $240,000 all of which she will pay to herself, how much will she take home under each method. Assume a corporate tax rate of 30%, and a personal tax rate of 25% on salary and 15% on dividend income.

Answer 1

Calculation of take home amount after tax:

Method 1: Pay Salary

Income of Theo Corp. will be NIL, since entire amount is paid as salary i.e. expenditure

Tax Liability = $0

Personal Tax Liability of Larissa = $240,000*25% = $60,000

Take home amount = $180,000

Method 2:

Income of Theo Corp = $240,000

Tax @30% = $72,000

Net Amount of Dividend = $168,000

Tax on Dividend @15% = $25,200

Take Home amount = $142,800

Hence, it is better to draw a salary