Constructive Dividends, Redeptions, and Related Party Losses

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Suppose you are a CPA hired to represent a client
that 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 (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 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
      Section 301 of the IRC.
    • Rental
      loss: The rental loss results from a building leased to the construction
      company owned by the client and his son.

Use the Internet and Strayer databases 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 (6) step tax research process in Chapter 1 and demonstrated in Appendix A
of your textbook as a guide for your written response.

Write a three to four (3-4) page paper in which you:

  1. 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.
  2. 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
  3. Propose
    a strategy for the client to receive similar amounts in compensation in
    the future and avoid the taxation as a constructive dividend.
  4. Use
    the six (6) step tax research process, located in Chapter 1 and
    demonstrated in Appendix A of the textbook, to record your research for
    communications to the client.

Your assignment must follow these formatting

    • Be
      typed, double spaced, using Times New Roman font (size 12), with one-inch
      margins on all sides; citations and references must follow APA or
      school-specific format. Check with your professor for any additional
    • Include
      a cover page containing the title of the assignment, the student’s name,
      the professor’s name, the course title, and the date. The cover page and
      the reference page are not included in the required assignment page

The specific course learning outcomes associated
with this assignment are:

    • Analyze
      tax issues regarding corporate formations, capital structures, income
      tax, non-liquidating distributions, or other corporate levies.
    • Prepare
      client, internal, and administrative documents that appropriately convey
      the results of tax research and planning.
    • Create
      an approach to tax research that results in credible and current
    • Use
      technology and information resources to research issues in organizational
      tax research and planning.
    • Write
      clearly and concisely about organizational tax research and planning
      using proper writing mechanics.

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