Constructive Dividends, Redemptions, and Related Party Losses – Essaylink

 

Suppose you are a CPA hired to represent a client who is currently under examination by the IRS. The client is
the president and 95% shareholder of a building supply sales and warehousing business. He also owns 50% of
the stock of a construction company. The client’s son owns the remaining 50% of the stock of the construction
company. The client has received a notice of proposed adjustments (NPA) on three 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 issues are
reflected below:
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.
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 IRC Section 301.
Rental loss: The rental loss results from a building leased to the construction company owned by the client and
his son.
Instructions
Use the Internet and Strayer Library to research the rules and income tax laws regarding unreasonable
compensation, stock redemptions treated as dividends, and related party losses. Be sure to use the six-step
tax research process in Chapter 1 that was demonstrated in Appendix A of your textbook as a guide for your
written response.
Write a 3–4 page paper in which you:
Based on your research and the facts stated in the scenario, prepare a recommendation for the client in which
you advise either acceptance of the proposed adjustments or further appeal of the issue based on the potential
for prevailing on appeal.
Create a tax plan for the future redemption of the client’s stock owned in the construction company that will not
be taxed according to Section 301 of the IRC.
Propose a strategy for the client to receive similar amounts in compensation in the future and avoid the
taxation as a constructive dividend.
This course requires the use of Strayer Writing Standards. For assistance and information, please refer to the
Strayer Writing Standards link in the left-hand menu of your course. Check with your professor for any
additional instructions.
The specific course learning outcome associated with this assignment is:
Create a recommendation for proposed adjustments, stock redemption, and future compensation based on a
given scenario.
Use references.

 

 

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