Constructive Dividends, Redemptions, and Related Party Losses
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.
Sample Solution
and trade routes. At dig sites at Cahokia, archaeologists discovered proof of a society in which “elite rulers claiming divine descent controlled the distribution of food,” (Calloway, p.35). There was also evidence of ritualistic sacrifice by the Mississippians. Another important factor of life in Mississippian society is agriculture. The rhythmic cycle between growing corn, beans, and squash reflected the life of the people living in Cahokia and other mound cities. The society was thriving until its eventual collapse due to the arrival of Europeans and the growth of a population who could not be supported by the resources.
2. What is “geomythology,” and how can it be used to learn about the ancient North American past? Answer this question while describing more broadly “how we know what we know” about Native North America prior to European contact.
Geomythology is a term that means the study of legends that strive to explain geological phenomenon such as volcanoes, earthquakes, and the like. These legends allow mythologists and historians to explore the deeper meaning behind Native American stories and to get a first-hand account on how Indians saw the world that they inhabited. Often times historians “do not know quite what to make of stories and consequently dismiss them as myths, not appropriate or useful as historical evidence,” however, “oral transmission of stories is common to all human societies and ‘is probably the oldest form of history making,’” (Calloway, “A Navajo Emergence Story and an Iroquois Creation Story,” p.44). In stories like the Navajo, where the First Man and First Woman emerge from several lower worlds in order to eventually find the present world, or the different Iroquois tribes, which all tell slightly different tales, a