22 143 explain how a constructive dividend result

This preview shows page 51 - 53 out of 54 pages.

Image of page 51

Subscribe to view the full document.

143. Explain how a constructive dividend result could occur in each of the following situations. a. A shareholder is employed by a corporation. b. A shareholder lends funds to the corporation. c. A shareholder sells property to the corporation. d. A shareholder rents property from a corporation. e. A shareholder drives a car owned by the corporation. a. If the salary paid to the shareholder-employee is deemed to be unreasonable, a constructive dividend results. This has the effect of converting the payment from compensation income to dividend income and makes it nondeductible to the payor corporation. b. The main problem with shareholder loans to the corporation is the thin capitalization danger. In this eventuality, the debt is reclassified as equity and any interest or debt repayment is a constructive dividend. c. If the property is sold for more than its fair market value, the excess is a constructive dividend. d. If the shareholder pays less than a fair rental for the property, the difference is a constructive dividend. e. If the use of the car is personal, the fair rental value of such use is a constructive dividend. 144. Jody, her parents, and her brother and sisters own all of the stock in Mauve Corporation. Discuss the various possible tax consequences to the parties involved if Jody borrows money from Mauve and the loan: a. Is not bona fide. b. Is bona fide but provides for no interest to be paid. a. A constructive dividend occurs. Jody must recognize dividend income as to the amount of the loan. Mauve Corporation cannot claim a deduction for the amount involved. b. Imputed interest results and is treated as a constructive dividend. The consequences of the imputed interest are: dividend income to Jody; gross income to Mauve; and possible interest deduction for Jody. 145. To bail out corporate profits at capital gain rates, stock redemptions are carried out. a. Is this still a meaningful approach? b. Why or why not? a. Yes. b. The redemption that is successful (i.e., treated as a sale or exchange) has one major advantage over the redemption that is not successful-it allows the shareholder to recover, free of tax, the basis in the stock being redeemed. The difference, then, between the successful and unsuccessful redemption is the amount of income that has to be recognized at capital gain rates. Prior to 2003 and the current dividend income rules, the tax consequences of an unsuccessful redemption were considerably more severe. Previously, dividend income was classified as ordinary income and taxed in full at the recipient’s marginal tax rate. 146. How can the Subchapter S election be lost? The S election may be terminated voluntarily when the holders of a majority of the shares choose to do so. An involuntary termination occurs when the entity ceases to qualify as a small business corporation. In certain cases, an involuntary termination occurs when the corporation has too much passive investment income.
Image of page 52
Image of page 53
You've reached the end of this preview.
  • Spring '12
  • honig
  • Corporation, Income tax in the United States, C CORPORATION

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern