Nittany Company pays its sole shareholder, Tammy Lion, a salary of $85,200. At t

Question

Nittany Company pays its sole shareholder, Tammy Lion, a salary of $85,200. At the end of each year, the company pays Tammy a "bonus" equal to the difference between the corporation’s taxable income for the year (before the bonus) and $72,500. In this way, the company hopes to keep its taxable income at amounts that are taxed at either 15 percent or 25 percent. This year, Nittany reported pre-bonus taxable income of $750,500 and paid Tammy a bonus of $678,000. On audit, the IRS determined that individuals working in Tammy’s position earned on average $339,000 per year. The company had no formal compensation policy and never paid a dividend. Refer Corporate tax table.

Explanation / Answer

Computation of additional Income tax liability does NIttany company face:
If IRS recharacterizes $212,100 as dividend, then the company's total taxable income will increase from &72,500 to ($212,100 + 72,500) = $285,000
Tax on Total income = $285,000:
On first 100,000 = $22,500 as per the table
On balance i.e., 285,000-100,000 = 185,000* *39% = $72,150
Total tax liability = 72,150 + 22,500 = $94,650
Less: tax on $72,500 =7,500+ (22,500*25%) = (13,125)
Therefore, additional tax liability = 94,650 - 13,125 = $81,525

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