Question

Your client, Bob, is the CEO of a corporation that has 12 stockholders who are also the only employees of the business. The corporation operates a boat dealership in Sherman, Texas. The corporation has accumulated earnings and profits of $3,000,000, not including the current year’s taxable income, which is expected to be $800,000. No dividends have been paid to stockholders. Bob has been very pleased with the corporation’s performance and he wants to reward the stockholders.

1. Why should Bob declare a cash dividend over giving stockholders a bonus?2. Why should Bob not consider paying a larger year-end bonus to his employee/stockholders’

Answer 1

1. Why should Bob declare a cash dividend over giving stockholders a bonus?

Bob should not declare a cash dividend, instead he should give the employees/stockholders a bonus. A corporation distributes dividends with their after tax income, while bonuses actually decrease net income and lowers taxes. it is always better to pay less taxes.

2. Why should Bob not consider paying a larger year-end bonus to his employee/stockholders’.

In this case, if you have to choose between declaring a dividend or paying a bonus, Bob should definitely pay a bonus. But the bonus should not be larger than the corporation's expected income. It is not a good idea to incur in an operating loss due to huge bonuses.