To: Flamingo Corporation

Date: 14/07/2013

Re: constructive dividend

IRS considers the transfer of large amounts of money to shareholders as constructive dividend and is a violation of the tax code. This means that it is up for penalties.

Money even if allocated to the person by the firm it is supposed to be taxed at the corporate level and then at the shareholders level as dividend. Penalties will be at the corporate level and at the shareholder’s level. in our case the penalty was the deductions for both John and Kenny.

In the court case of Welle v. Commissioner, it was determined that no constructive dividend occurred because the corporation was wholly owned by one person, however in our case it is owned by two people and controlled by a board made up of three people. if the allocation of the money to the share holders leads to a substantial reduction in the profits earned by the corporation, then under section 316(a), it is a constructive dividend. This is because it then becomes a form of distribution of the corporate assets and cash balances.

The treasury regulation section 1.482-1 states that even in controlled situations, any distribution of resources that tampers with the profits gained by a corporation is termed as constructive dividend. Even though in this case it was controlled because there was a clause enacted prior to the distribution of the money to the shareholders, it still qualifies as constructive dividends.

When a case is proofed to be a constructive dividend, then the gross income earned by the corporation and the shareholders will have increased tax based on what was constructed for the individual by the corporation. John will experience increased tax on his dividend share while Kenny will experience increased taxes on his pension. The corporation will also experience increased tax rate until the penalty amount is cleared.

References

Well v. Commissioner, 2009, Constructive Dividend Case A Mystery,

Treasury Regulation Section 1.482-1, 1.282-9, 316(a),

http://www.ustaxcourt.gov/InOpHistoric/graves.TCM.WPD.pdf