Constructive Dividends, Redemptions, and Related Party Losses
ACC 565 Organizational Tax Research and Planning
The facts
There are many companies controls in the IRC, and they have solid forces indicate in the same way. There are no advantages can be given to any shareholder more than entire paid to whatever other investors of the relationship in a similar circumstance and conditions. Restitution of stock held by the company is considered as the compensation to the companies. So, the company does not have the stock ownership anymore. The IRS decides clear up that the adversities, which are brought an outcome of any unapproachable activities, are not allowed in a circumstance where the compensation of the individual forms the inactive exercises performed. In this case, the client is the president and 95% shareholder of a building supply sales andwarehousing 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 issues
The client had received a Notice of Proposed Adjustments (NPA) which is related to his business. First, the IRS believes that the client currently receives an unreasonable compensation. The Notice argues that the client receives a fixed base salary of $5 million, 5% gross income based on receipts (not to exceed $5 million). The NPA states that they will not allow the 5% of income based on gross sales. Next, while the audit time, it has stock redemption which gives each 50% the stock but still the same ownership. The IRS thought it’s unfair under section 301 of the IRC. Finally, a rental loss which is from the results of the building leased by the client’s company.
The Applicable Law
First of all, IRC Section 162 enables the organization to take a conclusion for installments of pay rates and wages that are viewed as sensible. Segment 1.162-9 gives that rewards to representatives will comprise acceptable conclusions from gross salary when some basic honesty makes such installments and as an extra prize for the administrations rendered by the representatives, gave such installments, when added to the stipulated compensations, don’t surpass a sensible pay for the administrations rendered. It is insignificant whether such rewards are paid in real money or in kind or mostly in real money and incompletely in kind. The next one is “Section 301 requires a shareholder to include in gross income the amount of any corporate distribution to the extent it is treated as a dividend (1). These dividend distributions are taxable to the shareholder. A stock redemption is classified as either a sale of stock or a dividend payment. Finally, section 469 explains the rules regarding passive activity losses such as rental losses.
Authorities and Identification
This Notice of Proposed Adjustment has been issued to the customer by the International Revenue Service (IRS). The IRS is an administrative organization in charge of assessment gathering and checking for the United States of America.
Analysis
For the first issue, IRC regulation generally determine reasonable compensation by comparing the business under examination to similar businesses in the same industry. Since reasonable is interpretive, there have been several court cases to provide guidance when determining reasonable compensation. The independent investor test uses Return on Equity (ROE) to determine whether compensation is fair. Tax courts consider this method inaccurate when it is applied to multiple employees (2).
In spite of the fact that, the client and his son decreased their share by 50%, their level of possession did not change.
under Sec. 301……………………………………..
Finally, the IRC defines a passive activity as any action including ………………….
Conclusions and recommendation to the client
Concerning the case that the client gets unreasonable compensation, it is simple and reasonable for the state that $5 million base compensation in a 5% gross of offers (topped at $5 million) is unreasonable. As president and 95% investor, the organization is beneficence the client by getting $1 million per month as compensation for work. Next, the client’s activities by recovering past stock fall under segment 302 of the IRS rules (3).
This section reasons that any stock which is held by the organization and recovered is a type of pay to the organization in return for the stock. So, the organization never again holds that stock. As a CPA who represent this client, the issue of unreasonable compensation which I will be recommended the client perform the ROE calculations to determine if this would be a strong defense against the NPA for unreasonable compensation. If so, the client should appeal this determination. Be sure to include intangible assets like professional goodwill, leadership, the effect on employee morale and strategic decision-making abilities when justifying the compensation paid (4).
liquidation is the option for the stock redemption. Any future stock redemptions should be made so that the client’s ownership interest in the construction company is terminated. In addition, any other stock, the client should prepare for dividend treatment by the IRS. Finally, the claimed rental losses are considered to be passive. So, I would recommend that the client should accept the IRS, NPA due to a lease agreement is crucial. Moreover, the stated rental amount must be reasonable. I will consult with local realtors to find some information about rentals in the area. Also, the client should consider options for generating passive income, so that the passive rental losses can be claimed.
Reference
(1) Constantine, A. J. (August 2008). Avoiding the Self-Rental Trap. The Tax Advisor. Retrieved
from: http://www.thetaxadviser.com/issues/2008/aug/avoidingtheself-rentaltrap.html
(2) Kirkland, S. D. CPA/CFF. (September 2013). Preventing a challenge to (un)reasonable
compensation. Journal of Accountancy. Retrieved from:
http://www.journalofaccountancy.com/issues/2013/sep/20137412.html
(3) Panitz, P. G. (June 2009). Executive Compensation: What’s Reasonable? Journal of
Accountancy. Retrieved from:http://www.journalofaccountancy.com/issues/2009/jun/20081250.html
(4) Irs.gov, (2014). Passive Activity Loss ATG – Exhibit 2.4: Real Estate Professionals. Retrieved
