Tide Company pays its sole shareholder, Nick Sabar, a salary of $100,000. At the end of each year, the company pays Nick 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 keep its taxable income at amounts that are taxed at either 15 percent or 25 percent. This year, Tide reported pre-bonus taxable income of $675,000 and paid Nick a bonus of $600,000. On audit, the IRS determined that individuals working in Nick's position earned on average $300,000 per year. The company had no formal compensation policy and never paid a dividend. Assume Nick's marginal ordinary rate is 35 percent and his rate on dividends is 15 percent.
a. How much of Nick's bonus might the IRS recharacterize as a dividend?
b. What arguments might Nick make to counter this assertion?
c. Assuming the IRS recharacterizes $200,000 of Nicks's bonus as a dividend, what additional income tax liability does Tide Company face?