Question

Sunny, whose marginal tax rate on additional earnings is 35 percent on ordinary income and 15 percent on dividends, is the sole owner of the stock in Szafranski Corporation. The corporation earned $1 million for calendar year 2020 before these items: Salary to Sunny ($20,000 monthly) $240,000 Tax preferred benefits to Sunny (Medical, etc.) 70,000 The corporate tax rate is a flat 21 percent.

Write a memo to Sunny explaining the tax advantages/disadvantages of the salary and benefits and whether Sunny should considering increasing or decreasing the salary and/or the fringe benefits, if possible. How is any change in these amounts the result of “shifting” tax consequences? Explain.

Answer 1

Inorder to get more benefits of the tax it is advised to go for high dividend payout policy so that less burden on the sunny and the company . This high dividend payout ration can lead to an increase in total earnibgs the same is explained with given figures attached with this.

Advantages of Salary 1. Fixed monthly payouts irrespective of company performance 2. Allowable business expenditure 3. Get the befit of fringe benefit tax 4. Even at the time of liquidation of company also preference of getting payment on par with creditors. Disadvantages 1. Always fixed amount 2. No hike as to the risk 3. Higher tax rate as per the system. Taxation as an Individual Taxation of Corporate Particulars Amount Particulars Amount Salary 240,000 Earnings 1,000,000 Tax rate 35% 240,000 Salary Other benefits to Sunny Tax on Income 84,000 70,000 Net Salary 156,000 Net Earnings Earnings After Tax 690,000 545,100 Total Earnings from Business as well as Salary 701,100 Recommendation Instead of paying the salary he should think of providing dividend because the rate of dividend is only 15% which is lower than the tax on salary which is at 35%. Taxation as an Individual Particulars Dividend Taxation of Corporate Particulars Earnings Dividend Net Earnings Corporate Tax Rate Tax Earnings After Tax Amount 1,000,000 240,000 760,000 21% 159,600 Tax rate Tax on Income Net Salary Amount 240,000 15% 36,000 204,000 Its is assumed here that the dividend is taxed in the hands of the recipient 600,400 Total Earnings from Business as well as Salary 804,400 So, if we follow this option, we can increase the combined earnings by dollars 103,300(804,400-701100) We can also adopt the strategy of 100% payout ratio such that the more tax savings can be achieved. However, such type of policy is not good because if we are look for a long-term plan, we should go wealth maximization than profit maximization.