Constructive Dividends

Constructive Dividends

  • Submitted By: kbowman5
  • Date Submitted: 07/09/2015 5:46 PM
  • Category: Business
  • Words: 2104
  • Page: 9







Constructive Dividends, Redemptions, and Related Party Losses
Name
Education Institution
Professor
May 1, 2015

Constructive Dividends, Redemptions, and Related Party Losses
The Scenario (Facts)
The client has received a Notice of Proposed Adjustments (NPA) on three (3) significant issues related to the building supply business for the years under examination. The issues identified in the NPA are unreasonable compensation, stock redemptions, and a rental loss. Additional facts regarding the following issues:
1) Unreasonable compensation: The taxpayer receives a salary of $10 million composed of a $5 million base salary plus 5% of gross receipts not to exceed $5 million. The total gross receipts of the building supply business are $300 million. The NPA by the IRS disallows the salary based on 5% of gross receipts as a constructive dividend.
2) Stock redemptions: During the audit period, the construction company redeemed 50% of the outstanding stock owned by the client and 50% of the stock owned by the client’s son, leaving each with the same ownership percentage of 50%. The IRS treated the redemption as a distribution under Section 301 of the IRC.
3) Rental loss: The rental loss results from a building leased to the construction company owned by the client and his son.
Identify the Issues
There are three issues at hand, the first is the $5 million dollars received in conjunction with the 5% of the corporation’s earnings not to exceed $5 million, is this unreasonable compensation or should it have dividends as the IRS claims. The second is the sale of stock, should this be treated as a sale in accordance with IRC section 302 or IRC 301? The third issue is the rental loss on the taxpayers personally owned building being rented to the taxpayer’s corporation.
Applicable Authorities
The Internal Revenue Code (IRC) section 162(a)(l) permits a deduction for a reasonable allowance for salaries or other compensation for personal services....

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