Question

Assignment 2: Constructive Dividends Based on your readings for the module, respond to the following: Explain the concept of constructive dividends. Give examples. Construct three original examples of situations in which the IRS might claim constructive dividends. Suggest ways to ensure that constructive dividends are minimized or eliminated. Write a three- to five-page paper in MS Word format. Apply APA standards for writing style to your work.

Answer 1

• CONSTRUCTIVE DIVIDENDS :- A concept in U.S. taxation in which various distributions to shareholders are not labeled as dividends but are still considered dividends by the IRS and taxed as such. Constructive dividends are most commonly found in companies in which the employees are also the shareholders.

A constructive dividend is an undeclared dividend by the corporation, usually paid to one or only a few shareholders. It can be a direct payment of money, like a salary, or some other indirect economic benefit to the shareholder, like paying a shareholder's rent.

==>> For example, in many small companies, employees who are also shareholders may borrow money from the company to buy personal items. This loan may be classified by the IRS as a constructive dividend and must be reported on the tax return of the shareholder. In addition, the company would not be able to take a deduction for the constructive dividend.

==>> The IRS can call the payment a constructive dividend. If it does, the company may lose the tax benefit, and both the company and shareholder may face penalties.

Examples of the IRS might claim constructive dividends :-

Constructive dividends can take many forms, such as:

-->> Corporate payment of the shareholder's personal expenses that aren't related to the business, like rent or doctor's bills.

--> The second one is the transfer of a building from the company to another firm, which is owned by the shareholder. IRS might assert that such a transfer constitutes a constructive dividend if such transfer does not entail purchase and tax deductibility. The other firm belongs to the shareholder and is not part of the business organization that initially owned the building. Therefore, transferring the building to such a firm may be termed as a personal use of the property. The shareholder’s firm should buy the building at the market price, and the transaction should normally be taxed to avoid IRS's attention.

--> The third example of a situation that can lead to the occurrence of a constructive dividend is when a corporation considers gym fees for a shareholder as a medical cover. The condition can arise if the shareholder attends the gym to get an attractive body figure. Such a gym program does not contribute to preventing or curing a certain ailment thus IRS will deem it as a constructive dividend.

==>> Methods of Reducing or Eliminating Constructive Dividends

• Business organizations should adopt methods to ensure that constructive dividends are minimized or eliminate them altogether. Constructive dividends result from different scenarios and can cause adverse tax outcome thus the need to reduce them. A corporate or a shareholder can show the IRS that the organization did not have sufficient amounts of profits or earnings to give shareholders any dividend. Besides, they can proof such payments were not utilized for personal use but the normal company expenditures. If the shareholders or the organization uses the above defences, payment of dividends may not be classified as constructive dividends by the IRS.