M is the sole shareholder of N Corporation. For the past five years, N has reported little or no taxable income as aresult of paying M a salary of $500,000 per year. During a recent IRS audit, the revenue agent determined thatM's educational and business experience, and his time devoted to managing N, justified a salary of only$200,000. Thus, the agent recharacterized $300,000 of the payments from the corporation as a dividend.Assume that all dividends are taxed to the individuals at a 20% tax rate. What are the annual tax savings to M asa result of the constructive dividend treatment? Calculate the change in M's income tax liability as a result of thischange. Assume that M's marginal tax rate on ordinary income is 37 percent. (Ignore any payroll taxconsequences.)

Working notes:- M's Salary = $ 500000…

Answered: ducational and busi .000. Thus, the age

Business

Accounting

ducational and busi .000. Thus, the age

FINANCIAL ACCOUNTING

10th Edition

ISBN:9781259964947

Author:Libby

Publisher:Libby

Chapter1: Financial Statements And Business Decisions

Section: Chapter Questions

Problem 1Q

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Concept explainers

Contingent Liabilities and Provisions

A contingent liability can be defined as a liability the occurrence of which is dependent upon the happening of an uncertain future event. It is generally recorded in the books only when the amount of liability can be reasonably estimated and the contingency is likely to occur shortly.

Question

M is the sole shareholder of N Corporation. For the past five years, N has reported little or no taxable income as a
result of paying M a salary of $500,000 per year. During a recent IRS audit, the revenue agent determined that
M's educational and business experience, and his time devoted to managing N, justified a salary of only
$200,000. Thus, the agent recharacterized $300,000 of the payments from the corporation as a dividend.
Assume that all dividends are taxed to the individuals at a 20% tax rate. What are the annual tax savings to M as
a result of the constructive dividend treatment? Calculate the change in M's income tax liability as a result of this
change. Assume that M's marginal tax rate on ordinary income is 37 percent. (Ignore any payroll tax
consequences.)

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