Name:

Date:

Analytical and written exercise

CBA Poultry (CBA) is located in Oregon and only does business is Oregon. CBA files as a C Corporation following a calendar year, and Corey is the sole shareholder. During your audit of CBA, you discovered a $70,000 check withdrawal in the business bank account. You noticed that the depreciable assets increased by $70,000 during the year. Next, you looked at CBAs asset list and you found the following asset description Q Series 27 QSBA X2 Values and it was placed in service during the tax year under audit for $70,000. In your interview with Corey, you asked him about the asset and the business purpose of it. Corey said its his new party boat and since the business had a good year he wanted to get something his family and friends can enjoy with him. You followed up by asking if he took his clients out on the boat, and Corey said no way. You verified the purchase invoice for the boat and the boat is listed under Coreys name and not the businesss.

You have determined that Corey took money out of the business to purchase a boat for his personal benefit. For a C Corporation, a shareholders personal use of corporate funds is seen as a disguised dividend, also known as a constructive dividend. Constructive dividends are treated the same way as formally declared dividends. Overall, if the corporation distributes property (money) from its earnings and profits to their shareholders, then the distributed property will be classified as a dividend. If the corporation does not have earnings and profits from which to make the dividend, the benefit conveyed to the shareholder may be characterized as a return of capital or as capital gain.

Applicable laws:

IRC 301(a) - In general

Except as otherwise provided in this chapter, a distribution of property (as defined in section 317(a)) made by a corporation to a shareholder with respect to its stock shall be treated in the manner provided in subsection (c).

IRC 301(c) Amount taxable In the case of a distribution to which subsection (a) applies

(1)Amount constituting dividend

That portion of the distribution which is a dividend shall be included in gross income.

(2)Amount applied against basis

That portion of the distribution which is not a dividend shall be applied against and reduce the adjusted basis of the stock.

(3)Amount in excess of basis

(A)In general

that portion of the distribution which is not a dividend, to the extent that it exceeds the adjusted basis of the stock, shall be treated as gain from the sale or exchange of property.

IRC 317(a) Property

For the purposes of this part, the term property means money, securities, and any other property

Question 1:

Below is CBAs year-end equity account as originally reported on their tax return:

Common stock $ 1,000

Additional Paid in Capital $ 0

Retained earnings $30,000

After your findings how much of the distribution is considered taxable to Corey at the individual level? How much of the distribution is classified as a dividend? How much is classified as capital gains? Please show all of your calculations.

Question 2:

Corey claimed a ($3,000) capital loss on his Form 1040, line 13, during the same year under audit. His capital losses are derived from a long-term capital loss carryover from prior years. The carryover loss, after claiming the ($3,000) loss for the year is ($25,000). Our records do not show that Corey has filed the following years tax returns.

1. After distributions made at the corporate level, what is Coreys capital gain or loss on line 13 of the Form 1040? Please show your calculations:

2. Would you allow Corey to use the additional carryover loss of ($25,000) to offset any capital gains for the year under audit? Please explain.

Question 3: Please write an explanation of adjustment describing the distribution made to Corey. Keep your explanation to one page only.

Audit Report

CBA Poultry

The Sections writing style for explanation is as follows (plain language):

1. Brief law explanation (code cites)
2. Explain how the law is applicable to the taxpayers situation
3. State your determination in clear language and include the dollar amount.