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Nittany Company pays its sole shareholder, Joe Papa, a salary of $100,000. At the end of each year, the company pays Joe a bonus equal to the difference between the corporation's taxable income for the year (before the bonus) and $75,000. In this way, the company hopes to keep its taxable income at amounts that are taxed at either 15 percent or 25 percent. This year, Nittany reported prebonus taxable income of $675,000 and paid Joe a bonus of $600,000. On audit, the IRS determined that individuals working in Joe's position earned on average $300,000 per year. The company had no formal compensation policy and never paid a dividend.

a. How much of Joe's bonus might the IRS recharacterize as a dividend?

b. Assuming the IRS recharacterizes $200,000 of Joe's bonus as a dividend, what additional income tax liability does Nittany Company face?

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