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I have a single shareholder PS corporation that has had some

expenses disallowed. The corp...
I have a single shareholder PS corporation that has had some expenses disallowed. The corp will pay its tax. The RAR wants to assess the shareholder for constructive dividends.
I am disagreeing with that position because the corporation owes!!! the shareholder. The debt has the proper promissory note documentation from the date of the loan.(Which was used to purchase assets from an unrelated third party PS corp). I am using the "substance over form" argument that the reality is that the disallowed expenses don't reach the level of constructive dividends because the corp is in debt to the shareholder far in excess of the disallowed expenses. Do I have a leg to stand on?
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Answered in 18 minutes by:
6/21/2013
Lane
Lane, JD, CFP, MBA, CRPS
Category: Tax
Satisfied Customers: 12,876
Experience: Law Degree, specialization in Tax Law and Corporate Law, CFP and MBA, Providing Financial & Tax advice since 1986
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NPVAdvisor :

Here's an excellent definition of constructive dividend from a tax perspective:

NPVAdvisor :

A concept in U.S. taxation in which various distributions to shareholders are not labeled as dividends but are still considered dividends by the IRS and taxed as such. Constructive dividends are most commonly found in companies in which the employees are also the shareholders. You can think of a constructive dividend as an undeclared dividend by the company that involves the use of corporate assets.

NPVAdvisor :

I understand that the the corp is in debt to the shareholder far in excess of the disallowed expenses ...

NPVAdvisor :

I'm afraid, however, that it woud the the amount of the annual (tax year) debt service (P&I) that would the amont to "net against" in any tax year

NPVAdvisor :

NOthe total amount of debt

NPVAdvisor :

Does that make sense?

NPVAdvisor :

pardon the typos "NOT" the TOTAL amount of debt

NPVAdvisor :

I think your best case it to calculate the amount tht the corp would be liable in the tax yaer in question, and then THAT would be a subtraction from the amount they are calling a constructuve dividend

Customer:

The loan document representing the corp debt to the shareholder is a demand note for both i&p.

NPVAdvisor :

Ahhh then IF you recall, you MAY have a case ... but then again they will argue that (substance over form) you did this to esca[e the taxation of EFFECTIVE dividends

Customer:

The note is for $315,000 and about $25,000 per year is being deemed a constructive dividend

NPVAdvisor :

Because the demand note can be recalled upon the lenders request, assuming the notice required by the provisions of the loan are met, they may say that because there is no distinction between you and the PSC (again substance over form) you are evading the true dividend

NPVAdvisor :

... just trying to help you "see around corners" here, but they may say that declaring only 25K per year is a reasonable dividend

NPVAdvisor :

What THEY will argue is that what byou have is a "FORM over SUBSTANCE" argument

NPVAdvisor :

... still with me?

Customer:

He actually lent the money ($315,000) and zeroed out the profit each year to a Salary for which he received a W-2. Any use of corporate funds for personal use was charged to him and none was deducted. A note was prepared each year for any excess he took or for the corp if he didn't draw his salary. So a pattern was established. The audit created "new" for the corp after the fact and the corp will pay it's tax.

NPVAdvisor :

Wow, nicely done.

Customer:

That's "new Income" for the corp

NPVAdvisor :

Given the w-2 offset ....

NPVAdvisor :

and no deduction for personal use ...

NPVAdvisor :

If you prepare a statement outlining your logic, my professional opinion is that you do "have a leg to stand on."

NPVAdvisor :

Be sure to mlink the salary as you have have done here

NPVAdvisor :

"link"

Customer:

having established a pattern of documenting the overages and underages(??) with notes for over 28 years I'm just a bit miffed that the agent has changed our accounting methods to serve his purposes

NPVAdvisor :

And the statement that you understand the tax liability to come ... once it's due

NPVAdvisor :

I would really consider asking for an appeal to a manager here ... you need to get past the "front lines"

NPVAdvisor :

You state this very well; "can be recalled upon the lenders request, assuming the notice required by the provisions of the loan are met. ... the agent has changed our accounting methods to serve his purposes"

NPVAdvisor :

some one has looked at this ... out of context

Customer:

My client is actually wondering if he is being targetted because he actually is Tea Partyist and has joined about a dozen of their organizations

NPVAdvisor :

:) ... would not be surprised .... especially if this started before everything "went public."

NPVAdvisor :

If that's the case, the time might be right for a STRONG assertion of OBVIOUS manipulation, and a myopic point of view

NPVAdvisor :

... don't be too obvious, but the innuendo shouldn't be too obscure (given the audience)

Customer:

Ok thanks for your input

NPVAdvisor :

I thinl you have a good case, IF you get to someone above the front lines level

Customer:

I'm old school-how do print out your answers for my files

NPVAdvisor :

ok ... three options: bookmark this (everything will stay active if you bookmark - save as a favorite place in your browser) .... use the "file, print" command from your browser to print to either a file or paper .... or copy and paste to a document, such as Microsoft Word

Customer:

Ok I can do the "favorite" thing, the rest my staff can handle when they return in the morning

NPVAdvisor :

Very good

Customer:

Do you require/desire/want/need more money?

NPVAdvisor :

YOu can always just come back here throgh justanswer as well

NPVAdvisor :

Your positive rating is thanks enough

NPVAdvisor :

If this HAS helped, I would appreciate a feedback rating of 3 (OK) or better … That's the only way they will pay us here.


HOWEVER, if you need more on this, PLEASE COME BACK here, so you won't be charged for another question.

Customer:

Ok goodnight

Lane
Lane, JD, CFP, MBA, CRPS
Category: Tax
Satisfied Customers: 12,876
Experience: Law Degree, specialization in Tax Law and Corporate Law, CFP and MBA, Providing Financial & Tax advice since 1986
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Thanks for the rating!

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If you'd like to work with ME again just say "For Lane only," at the beginning of your next question.


Thanks again,
Lane
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Lane
Lane
Lane, JD, CFP, MBA, CRPS
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