Robin Corporation would like to transfer excess cash to its sole shareholder, Adam, who is also an employee. Adam is in the 28% tax bracket, and Robin is in the 34% bracket.
Because Adam’s contribution to Robin’s profit is substantial, Robin believes that a $25,000 bonus in the current year is reasonable compensation and should be deductible in full. However, Robin is considering paying Adam a $25,000 dividend because Adam’s tax rate on dividends is lower than his tax rate on compensation. Is Robin correct in believing that a dividend is the better choice? Why or why not?