Hammer, Inc., founded by John Hammer in 1962, sells hardware, building supplies, and related products through retail stores located throughout the Southwest. Mr. Hammer has been CEO of the company since its inception and he owns 100 percent of the company’s voting shares and 56 percent of the company’s nonvoting shares. In 1998, Mr. Hammer’s total compensation exceeded $20 million and included a salary of $157,500, a profit-sharing bonus of $3 million, and his “5 percent” bonus of $17.5 million. Upon audit, the Tax Court believed the total compensation package was excessive and the “5 percent bonus” was intended to be a dividend. If upheld, Hammer, Inc. would face a severe tax liability as dividends are not deductible, but performance based compensation (such as the 5 percent bonus) is deductible. In this instructional case, students evaluate the taxable implications of the bonus plan and determine whether the payment in 1998 should be classified as a deductible expense or a dividend.