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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:

  1. 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.)
  2. 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.)
  3. Determine the total impact on Treasury tax collections as a result of this audit finding.

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