Chap15 - Chapter 15 Compensation and Retirement Planning...

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Chapter 15 - Compensation and Retirement Planning Chapter 15 Compensation and Retirement Planning 1. A rank-and-file employee generally must accept the employment terms offered by management without any direct negotiation to tailor the terms to the employee’s specifications. The lack of negotiation is characteristic of a public market transaction. However, if rank-and-file employees unionize, the union has the power to negotiate with management to improve the terms of the employment contract between labor and management. This bilateral negotiation is characteristic of a private market transaction. 2. An employer directs and controls how, when, and where an employee’s duties are performed. The relationship between employer and employee is on going and exclusive. A client agrees to pay an independent contractor for services, but the contractor retains control over how, when, and where the services are performed. The duration of the client-contractor relationship is limited, and the independent contractor may perform services for many clients during the same time period. 3. MK Company may provide valuable fringe benefits (health and life insurance coverage, etc.) to its employees that are not available to Mr. U as an independent contractor. As an employee, Mr. U would owe employee payroll tax on his compensation from MK Company, which the company would withhold from his paychecks and remit to the government on his behalf. As an independent contractor, Mr. U’s self-employment tax would be twice the payroll tax, and he would be responsible for payment. 4. If the IRS discovers that an employer failed to withhold the proper payroll tax from the salaries and wages paid to its employees, it is more convenient and less costly for the IRS to collect the aggregate unwithheld tax from one party (the employer) which is already under audit than to collect a small unpaid tax from any number of individuals who may or may not still work for the employer. 5. The sole shareholder of a regular corporation wants to extract cash from the corporate business at the least income tax cost. If the corporation accounts for a cash distribution to a shareholder as a salary payment, the corporation can deduct the payment, thereby reducing its taxable income. In contrast, a dividend distribution does not reduce corporate taxable income. Thus, salary payments to the shareholder may be unreasonably high to maximize cash flow while minimizing the corporation’s after-tax cost of the payment. The sole shareholder of an S corporation pays income tax on the entire net income generated by the corporate business, regardless of the cash extracted from the business. However, the corporation and shareholder pay FICA payroll tax only on salary payments and not on cash distributions of net income. Thus, salary payments to the shareholder may be unreasonably low to minimize FICA payroll tax cost.
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