question 3

Mis the sole shareholder of N Corporation. For the past five years, N has reported little or no taxable income as a result of paying Ma salary of $500,000 per year. During a recent IRS audit, the revenue agent determined that M's educational and business experience, and his time devoted to managing N, justified a salary of only $200,000. Thus, the agent recharacterized $300,000 of the payments from the corporation as a dividend. Assume that all dividends are taxed to the individuals at a 20% tax rate. What are the annual tax savings to Mas a result of the constructive dividend treatment? Calculate the change in M's Income tax liability as a result of this change. Assume that M's marginal tax rate on ordinary income is 37 percent. (Ignore any payroll tax consequences)