The recently enacted Jobs and Growth Tax Relief Reconciliation Act of 2003 contains numerous provisions designed to stimulate the economy through tax reduction. Among the provisions decreasing Federal taxes is a reduction in the tax on corporate dividends received by individuals and certain other shareholders. This reduction in the dividend tax rate presents an opportunity for some closely-held businesses and their owners to reduce their overall tax obligation by reducing shareholder salaries and paying a corporate dividend in its place.

Consider ABC Corporation which generally pays no corporate income tax whose sole shareholder Max is employed by ABC and is subject to tax at the maximum individual income tax rate of 35%. Assume that Max’s salary is reduced by $50,000 and ABC Corporation declares a $50,000 dividend so that Max receives the same aggregate payment from ABC. The Federal income tax on the first $50,000 of corporate income is $7,500 and the tax on $50,000 of dividend income to Max will be $7,500 so that the total Federal tax incurred by ABC and Max will be $15,000. As a result of the reduction in salary, Max will save Federal income tax of $17,500 ($50,000 x 35%). ABC and Max will also jointly enjoy a reduction of the 2.9% Medicare tax imposed on Max’s salary resulting in a further Federal tax reduction of $1,450. As a result of the reduction in salary and the payment of the dividend, ABC and Max can collectively reduce their Federal tax bill by almost $4,000. In other circumstances, the tax reduction can be even larger.

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By Bruce E. Bell.  Partner, SFNR
Bruce Bell joined the Firm as a partner in 1995. He is also a Certified Public Accountant. Bruce maintains a general corporate practice with a concentration in Federal tax matters, including tax-oriented transactions, estate planning and retirement planning.