Corporate Tax Act400
Portfolio Project ACT400
Corporate Tax-ACT400
September 1st, 2012
Portfolio Project ACT400
I. Problem 1-Osprey Corporation
a. Facts
Dan and Patrick Zimbrick, sole shareholders of Osprey Corporation have been required to repay compensation to Osprey Corporation that was found by the IRS to be excessive. In order to determine how these repayments are to be treated for tax purposes, it is important to note that in 2006 the board of directors made up of Dan, Patrick and their uncle John, adopted a legally enforceable resolution. The resolution stipulated that any overpayment of salary disallowed as a deduction by the IRS would be repaid to the Osprey Corporation. In late 2010 during an audit by the IRS, $200,000 of Patrick’s compensation, and $150,000 of Dan’s compensation were recharacterized as constructive dividends. This was done because the salaries were found to be excessive. Reg §1.162-8 states excessive compensation will be disallowed to the corporation and treated as a constructive dividend to the shareholder. Because the agreement to the resolution was in place prior to their salary payments, the repayments were legally enforceable under state law. As stated by Hoffman, Raabe, Smith and Maloney “the constructive dividend serves as a substitute for actual distributions and is usually intended to accomplish some tax objective not available through the use of direct dividends. Alternatively the shareholders may be seeking benefits for themselves while avoiding the recognition of income”(2012, 5-16). Because the resolution did contain a repayment provision it should reduce the effect of the constructive dividends on Dan and Patrick.
b. Issues
A corporation cannot take a deduction from the constructive dividend, and the shareholder must report the amount of the constructive dividend on their tax return. The IRS will recharacterize an item that has been deducted on the corporate tax return to a non-deductible
Corporate Tax-ACT400
September 1st, 2012
Portfolio Project ACT400
I. Problem 1-Osprey Corporation
a. Facts
Dan and Patrick Zimbrick, sole shareholders of Osprey Corporation have been required to repay compensation to Osprey Corporation that was found by the IRS to be excessive. In order to determine how these repayments are to be treated for tax purposes, it is important to note that in 2006 the board of directors made up of Dan, Patrick and their uncle John, adopted a legally enforceable resolution. The resolution stipulated that any overpayment of salary disallowed as a deduction by the IRS would be repaid to the Osprey Corporation. In late 2010 during an audit by the IRS, $200,000 of Patrick’s compensation, and $150,000 of Dan’s compensation were recharacterized as constructive dividends. This was done because the salaries were found to be excessive. Reg §1.162-8 states excessive compensation will be disallowed to the corporation and treated as a constructive dividend to the shareholder. Because the agreement to the resolution was in place prior to their salary payments, the repayments were legally enforceable under state law. As stated by Hoffman, Raabe, Smith and Maloney “the constructive dividend serves as a substitute for actual distributions and is usually intended to accomplish some tax objective not available through the use of direct dividends. Alternatively the shareholders may be seeking benefits for themselves while avoiding the recognition of income”(2012, 5-16). Because the resolution did contain a repayment provision it should reduce the effect of the constructive dividends on Dan and Patrick.
b. Issues
A corporation cannot take a deduction from the constructive dividend, and the shareholder must report the amount of the constructive dividend on their tax return. The IRS will recharacterize an item that has been deducted on the corporate tax return to a non-deductible
References: Hoffman, W., Raabe, W., Smith, J., & Maloney, D. (2011). Corporations: introduction and operating rules. Corporations, partnerships, estates & trusts. Mason, OH: South-Western Cengage Learning. Ellentuck, A. B. (2011). PROVIDING FRINGE BENEFITS TO S CORPORATION EMPLOYEES. Tax Adviser, 42(12), 862-863. "Capturing Capital Gain While Staying in the Deal and Preserving Capital Gains in Real Estate Transactions (Related Article)" (2005). William & Mary Annual Tax Conference. Paper 68. http://scholarship.law.wm.edu/tax/68