Q:
Nittany Company pays its sole shareholder, Joe Papa, a salary of $100,000. At the ending of each year, the company pays Joe a bonus equal to the difference between the corporation's taxable income for the year before the bonus and $75,000. In this way, the company hopes to remain its taxable income at amounts that are taxed at either 15% or 25%. This year, Nittany reported pre-bonus taxable income of $675,000 and paid Joe a bonus of $600,000. On audit, the IRS evaluated that individuals working in Joe's position earned on average $300,000 per year. The company had no formal compensation policy and never paid a dividend.
a. How much of Joe's bonus might the IRS re-characterize as a dividend?
b. Supposing the IRS re-characterizes $200,000 of Joe's bonus as a dividend, what additional income tax liability does Nittany Company face?