Maximizing Tax Efficiency: Bonuses vs
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Tax module 2 - Should Bob consider paying a large year-end
bonus to each employee instead of
Federal Income Tax of Corporations & Partnerships (Southern New Hampshire
University)
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Tax module 2 - Should Bob consider paying a large year-end
bonus to each employee instead of
Federal Income Tax of Corporations & Partnerships (Southern New Hampshire
University)
Scan to open on Studocu
Studocu is not sponsored or endorsed by any college or university
Downloaded by robert henry (rhenryg314@gmail.com)
lOMoARcPSD|11686649
There are a few different advantages and disadvantages between bonuses vs dividends. Salaries and bonuses are deductible to the corporation, whereas dividends are not. Each dollar spent as a bonus, the corporation is saving money by not being taxed on it. Since the dividends would be payed to employees and not corporations, dividend received deduction does not apply here. Shareholders are taxed at a maximum
of 20% for their dividends if the corporation has a higher amount of earning and profits than dividends paid (IRS, 2016). In this case, the corporation has earnings and profits of
$300,000 and would be paying dividends of $120,000 so shareholders would be taxed in dividend income. As a shareholder’s perspective a maximum tax rate of 20% would be preferred since they could be paying less taxes as opposed to including it in their taxable income. However, paying the bonus would benefit the corporation a lot more because they would be limiting the amount of corporate tax. Due to the fact there are only 12 shareholders, it is considered a closely held corporation. Under 26 U.S. Code § 162 compensation is only deductible if it is a reasonable amount for the services rendered. Even if Bob pays his shareholders with a bonus, there is a chance it will be deemed unreasonable salary and will be reclassified as a dividend declared (IRS, 2016). Therefore, it would make the most sense for Bob to consider declaring dividends because it will benefit the shareholders, and paying bonuses would put the corporation at risk of them being reclassified as dividends anyways.
If Bob decides to give each employee a new boat that cost $10,000 and has a FMV of $15,000 the corporation would also be taxed on a capital gain of $60,000 on the distribution. Shareholders would be taxed as dividend income with a basis of $15,000 each (IRS, 2016). Bob should consider declaring dividends for his shareholders instead of giving them a boat. Dividends would not be deductible but he would be able to avoid paying taxes on the capital gain from the property distribution. The lending of the corporate plane is subject to tax consequences. Since the corporate plane is being used for vacation it is considered for personal use. According to
Regs. Sec. 1.61-21(g) using an employer-owned airline for personal use, you are taxed on the valuation of the flight as taxable income (AICPA, 2017). Additional options for Bob to minimize corporate tax is to offer tax-free fringe benefits.
Certain fringe benefits like health benefits, educational assistance, etc. are non-taxable and reduce the taxable income for the corporation (IRS, 2017). Since all the shareholders are also employees in the corporation they would benefit as well.
26 CFR 1.61-21 - Taxation of fringe benefits. (n.d.). Retrieved from https://www.law.cornell.edu/cfr/text/26/1.61-21
26 U.S. Code § 162 - Trade or business expenses. (n.d.). Retrieved from https://www.law.cornell.edu/uscode/text/26/162
Publication 15-B (2017), Employer's Tax Guide to Fringe Benefits. (n.d.). Retrieved from
https://www.irs.gov/publications/p15b
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Publication 542 (12/2016), Corporations. (n.d.). Retrieved from https://www.irs.gov/publications/p542#en_US_201609_publink1000257844
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