Steps of Tax Research-2348322

The president of Jones and Son’s Building Supply and Warehousing, Dave Jones, works about 4 hours a week and makes about as much salary as a full time executive to oversee a company with over 500 employees. Of course this raises questions about how reasonable his compensation is. Also, Dave and his son Junior, have equal shares of a construction company that they co own. After the audit period, the construction company redeemed a total of 50% of Dave’s and Junior’s stock. They made this decision after meetings of the board to reduce tax liability. Junior needed to raise funds to buy a vacation home and stock redemption was preferred over loans or dividends, because it would likely mean lower tax obligations. The gain is to be treated as a capital gain pursuant to the redemption designed to redeem Dave.

Step 1: Summarize the Facts

The IRS audit identified three key issues:

1. How reasonable was Dave’s compensation, considering his few work hours.
2. Whether the stock redemptions should be treated as sales or as capital gains (exchanges) of the stock or as dividend distributions (ordinary income).
3. The validity of a claimed rental loss.

Step 2: Identify the Issues

1. Unreasonable Compensation: How reasonable is Dave Jones’s remuneration for such minimal hours of work, and for comparable industry standards?
2. Stock Redemptions: Should the redemption of stock be considered as a sale or exchange for tax treatment of capital gains or does it constitute taxable income by due to its similarity to dividend distributions?

• Rental Loss: Is the claimed rental loss consistent with active participation or material participation requirements under IRS rules?

Step 3: Locate Applicable Authorities

1. Unreasonable Compensation:
2. IRC Section 162(a)(1): It permits deduction of amounts required to be paid for services rendered.
3. Regulation §1.162-7(b): Defines criteria for setting reasonable compensation, which considers the amount of compensation against the services provided. (Internal Revenue Code, n.d.)
4. Stock Redemptions:
5. IRC Section 302(b): defines the conditions under which stock redemptions are to be treated as sales or exchanges rather than as dividend distributions.
6. Regulation §1.302-2: Describes criteria under which a stock redemption is to be considered substantially identical to a dividend.
7. Rental Loss:
8. IRC Section 469: Explains passive activity losses, including when they are deductible and when they cannot be deducted (when the passive activity losses far exceed passive activity income).
9. Regulation §1.469-2: Details rules governing passive activity losses and exceptions for active participation in rental real estate activities. (Internal Revenue Code, n.d.)

References

Internal Revenue Code (IRC) Section 162(a)(1): “Trade or Business Expenses.” Available at: https://www.irs.gov/

Internal Revenue Code (IRC) Section 469: “Passive Activity Loss Rules.” Available at: https://www.irs.gov/