Hot Constructive Dividend Scenarios

1. Hot Constructive Dividend Scenarios 1. Excessive compensation to shareholder-employees 2. Corporation payment of personal shareholder expenses 3. Equity disguised as debt – the interest deduction and return of capital issue 4. Excessive shareholder rental 5. Phony family employment 6. Personal use of corporate assets 7. Bargain sales or rentals of corporate property 8. Brother – Sister Corp 482 Trap Corporate & Partner Tax Instructor: Dwight Drake

2. Trap Four: Section 482 – Rev. Rule 69-630 Bargain sale C Corp A C Corp B Imputed Income Imputed Dividend Imputed Contribution Common owners Corporate & Partner Tax Instructor: Dwight Drake

3. 243 Deduction Protectors 1. 246 – Stock not held long enough 2. 249A - Debt financed stock ownership 3. 1059 - Extraordinary dividends – 2 yr rule and consolidated return rule 4. The Waterman Bootstrap Acquisition Corporate & Partner Tax Instructor: Dwight Drake

4. Problem 541 June 1: P Corp stock trades at 15 – declares dividend $1 per share. Record date – June 8. Payment date – June 12 June 3: I Corp buys 1000 shares for 15k, collects $1000 dividend on June 10 June 15: I Corp sells stock for 14k Tax consequences to I Corp? Desire to have 243 shelter 70% of 1k dividend and have 1k STCL. But flunk excess 45 holding period of 246(c). So, no 243 deduction. All 1k dividend taxable. Sale date Dec 1. 246(c) not apply – more than 45 days satisfied. 243 deduction of 70% allowed. Corporate & Partner Tax Instructor: Dwight Drake

5. Problem 541 June 1: P Corp stock trades at 15 – declares dividend $1 per share. Record date – June 5. Payment date – June 10 June 3: I Corp buys 1000 shares for 15k, collects $1000 dividend on June 10 June 15: I Corp sells stock for 14k Sale still on Dec 1, but second dividend of $1 paid on August 15 (ex date 8/5)? Per 1059(c)(3)(A), dividends with ex-dates within 85 days treated as one dividend for 10% excessive dividend to basis rule. Here, 2k dividend over 10% of 15k basis. Effect under 1059(a) is that basis reduced by non-taxable portion - $1400. Hence, stock basis reduced to 13,600 (15k less 1400). Note, 243 deduction still allowed, but creates basis reduction. When stock sold for 14k, have 400 gain. Corporate & Partner Tax Instructor: Dwight Drake

6. Problem 541 June 1: P Corp stock trades at 15 – declares dividend $1 per share. Record date – June 5. Payment date – June 10 June 3: I Corp buys 1000 shares for 15k, collects $1000 dividend on June 10 June 15: I Corp sells stock for 14k I Corp receives 2k dividends, but holds 25 months before sale. 1059(a) still applies. Stock must have been held 2 years before dividend announcement date. Holding period after not relevant. Hence, 243 deduction (70% - 2100) would reduce basis to 12.9k. Corporate & Partner Tax Instructor: Dwight Drake

7. Problem 541 I Corp borrowed 15k to buy stock, paid 1200 interest and received 1000 dividend? What result? No 243 dividend deduction per 246(a). “Average Indebtedness Percentage” is 100%, so entire deduction lost. What if debt 7.5k? Then “Average Indebtedness Percentage” 50% under 246A. Half of 243 deduction disallowed. Deduction reduced to 35% or net $350. Corporate & Partner Tax Instructor: Dwight Drake

8. Problem 554 Basic Facts: S Corp hold X Corp stock more than 2 yrs, not part of consolidated group. Basis in stock 150k. - X Corp pays 100k dividend to S Corp. Plenty of E&P. - B buys X Corp stock from S for 400k. - Goal: 100k dividend sheltered 70% buy 243; capital gain on sale reduced 100k. Will it work? It’s the Waterman, TSN, Litton Industries issue. Note, if held stock for less than 2 yrs or consolidated return, than basis in stock reduced by tax-free dividend per 1059 and plan fails. Here, 1059 not apply. Risky if can’t show business purpose (TSN) or unrelated acts (Litton). Was dividend cash unwanted by buyer? Step Transaction/Sham doctrines may kill under Waterman rationale. Corporate & Partner Tax Instructor: Dwight Drake