You are retained by the law firm of D, E & F, PC (hereinafter referred to as the PC) to represent it and its shareholders in connection with a civil examination being conducted by the Internal Revenue Service. The PC is a professional corporation engaged in the general practice of law. D, E and F are equal shareholders in the PC and are also its principal officers and directors. The PC files a calendar year 1120 and employs the cash receipts and disbursements method of accounting. In August, 2015 D, as the attorney of record, was engaged to represent the Estate of John Smith in a wrongful death action against Inter-district Telephone Company. In August, 2016, the parties to the Smith case entered into a settlement agreement. In pertinent part, the agreement provided for a lump sum payment to the Estate and for an attorney's fee in the amount of $ 3,000,000 to be paid to Attorney D. D received payment of the attorney's fee in September, 2016. D retained $ 1,000,000 and disbursed $ 1,000,000 to E and $ 1,000,000 to F. D reported receipt of the $ 3,000,000 as income on Form 1120 U.S. Corporation Income Tax Return, and claimed a deduction in the amount of $ 2,000,000, which represented the aggregate amount disbursed to E and F. All three distributions of $1,000,000 each were treated as payments for compensation and were deducted on the corporate tax return as an allowable expense under IRC 162. D, E and F inform you that the IRS agent has just concluded his examination of the PC's 2016 return and the 2016 individual returns of D, E and F. The IRS agent agrees that the $3,000,000 received was properly reported as taxable income on the corporate tax return. Week 5 Assignment Tax Issue Analysis Write-Up 2 However, the agent challenges that the distributions to D, E and F, could be treated as payment of compensation deductible as an expense on the corporate tax return. The IRS agent proposes to characterize the $ 3,000,000 received by D, E and F as a distribution of the earnings and profits of the PC, taxable as dividend income in the amount of $ 1,000,000 each. The basis for the agent's determination that the payments should be treated as a dividend distribution which is taxable to the parties is set forth in IRC 301(c) and Treas. Regs. 1.301-1. Furthermore, the agent rejects any argument that the payments to D,E, and F are deductible as compensation paid for services rendered by D, E and F. The agent contends that the compensation paid by the PC to D, E and F, which was $250,000 each per year was reasonable for similar attorneys practicing in their capacity and specialty of law. Therefore, he concludes, amounts in excess of those already claimed would be excessive and non-deductible. The agent relies on I.R.C. 162(a) and Treas. Regs. 1.162-7 for this position. Assignment: D, E and F want your opinion as to the merits of the government's case and, whether they should agree or disagree with the agent. They understand that you need some time to evaluate this matter. They ask you to get back to them as soon as possible. Read the relevant code and regulations sections relied upon by the government and prepare your response to the clients in proper form.