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Graham is the sole shareholder of Logan Corporation. For the past five years, Logan has reported little or no taxable income as a result of
Graham is the sole shareholder of Logan Corporation. For the past five years, Logan has reported little or no taxable income as a result of paying Graham a salary of $500,000 per year. During a recent IRS audit, the revenue agent determined that Grahams educational and business experience, and his time devoted to managing Logan, justified a salary of only $200,000. Thus, the agent recharacterized $300,000 of the payments from the corporation as a dividend. Assume that all dividends are taxed to the individuals at a 20% tax rate.
Required:
- Calculate the additional income tax liability for Logan as a result of this constructive dividend treatment. Assume Logan's marginal tax rate for the year in question was 34 percent. (Ignore any payroll tax consequences.)
- What are the tax consequences to Graham as a result of the constructive dividend treatment? Calculate the change in Grahams income tax liability as a result of this change. Assume that Grahams marginal tax rate on ordinary income is 37 percent. (Ignore any payroll tax consequences.)
- Determine the total impact on Treasury tax collections as a result of this audit finding.
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