FACTS: Mr. Smith is the 100% shareholder of Smith, Inc. The corporation was formed in 1980 and has experienced a great deal of growth and success through the years. Currently, E & P of the corporation is $4,500,000. The corporation is in the 21% marginal tax bracket and Mr. Smith is in the 35% marginal tax bracket. Mr. Smith has asked you whether the corporation should pay him a $150,000 dividend this year, or increase his compensation by the $150,000. You are to assume the marginal tax brackets will not change and that the additional $150,000 of compensation will be considered reasonable. (Ignore payroll taxes).

Mr. Smith wants to know which alternative is better (dividend or additional compensation) from the standpoint of total taxes paid by the corporation and by himself and has asked for advice from you. Show computations used to arrive at your recommendation.