Suppose you are a CPA hired to represent a client that is currently under examination by the IRS. Theclient is the president and 95% shareholder of a building supply sales and warehousing business. He alsoowns 50% of the stock of a construction company. The remaining 50% of the stock of the constructioncompany is owned by the client's son. 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 $5million base salary plus 5% of gross receipts not to exceed $5 million. The total gross receipts ofthe building supply business are $300 million.
The NPA by the IRS disallows the salary based on5% of gross receipts as a constructive dividend? Stock redemptions: During the audit period, the construction company redeemed 50% of theoutstanding stock owned by the client and 50% of the stock owned by the client's son, leavingeach with the same ownership percentage of 50%. The redemption was treated as a distributionunder Section 301 of the IRC by the IRS.?
Rental loss: The rental loss results from a building leased to the construction company owned bythe client and his son.Use the Internet and Strayer databases to research the rules and income tax laws regardingunreasonable compensation, stock redemptions treated as dividends and related party losses. Be sure touse the six (6) step tax research process in Chapter 1 and demonstrated in Appendix A of your textbookas 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 theclient in which you advise either acceptance of the proposed adjustments or further appeal of theissue 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 constructioncompany that will not be taxed according to Section 301 of the IRC.
3. Propose a strategy for the client to receive similar amounts in compensation in the future andavoid the taxation as a constructive dividend.