Question

Use references within RIA Checkpoint to support your conclusions.

Prepare a memo CPA use the format of https://owl.purdue.edu/owl/subject_specific_writing/professional_technical_writing/memos/format.html

Research Problem 1 (Chapter 19)—Kenny Merinoff and his son, John, own all of the outstanding stock of Flamingo Corporation. Both John and Kenny are officers in the corporation and, together with John’s uncle, Ira, comprise the entire board of directors. Flamingo uses the cash method of accounting and has a calendar year-end. In late 2011, the board of directors adopted the following legally enforceable resolution (agreed to in writing by each of the officers):

Salary payments made to an officer of the corporation that shall be disallowed in whole or in part as a deductible expense for Federal income tax purposes shall be reimbursed by such officer to the corporation to the full extent of the disallowance. It shall be the duty of the board of directors to enforce payment of each such amount.

In 2017, Flamingo paid Kenny $800,000 in compensation. John received $650,000. On an audit in late 2018, the IRS found the compensation of both officers to be excessive. It disallowed deductions for $400,000 of the payment to Kenny and $350,000 of the payment to John. The IRS recharacterized the disallowed payments as constructive dividends. Complying with the resolution by the board of directors, both Kenny and John repaid the disallowed compensation to Flamingo Corporation in 2019. John and Kenny have asked you to determine how their repayments should be treated for tax purposes. John is still working as a highly compensated executive for Flamingo, while Kenny is retired and living off his savings. Prepare a memo for your firm’s client files to describe the results of your research.

Partial list of research aids:

§ 1341.

Vincent E. Oswald, 49 T.C. 645 (1968).

Use references within RIA Checkpoint to support your conclusions.

Use the memo format of Exhibits 2.9 in your textbook.

Answer 1

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Solution:

TAX FILE MEMORANDUM

2019 ******

From: Jon S. Davis

Subject: Settlement agreement among the Merinoffs and Flamingo Corporation

Facts: Kenny and John Merinoff both are the sole stockholders of Flamingo Corp. Both are also executives of the corporation and also both are members of the board of directors in corporation. In year 2007, the Merinoffs enter into a repayment agreement with Flamingo, which predetermined that both will reimburse the business for any salary that was afterward disallowed as a deduction by the Internal Revenue Service. In late year 2012, the Internal Revenue Service re characterized $200,000 of John’s 2011 salaries and $150,000 of Kenny’s 2011 salary as beneficial dividends, disallowing Flamingo’s payment deduction for these values. Pursuant to the 2007 agreement, Kenny and John repay the worth of money disallowed to Flamingo this year.

Issues: How can the repayment or return of money by Kenny and John be considered for income tax purposes or point of view?

Discussion: As per the Section 162(a) permits a deduction for ordinary or common and essential business expenses. The main question at this time is whether the repayment of amount by Kenny and John would be deductible as an normal and essential business expense or, on the other hand, whether a credit for the refund would be allowed under section § 1341. Reg. § 1.162-1 gives that ordinary or common and vital expenses directly associated with or be relevant to the taxpayer’s trade or company are deductible from gross profit/income as company expenses.

As per the Section 1341 presents the likelihood of a credit for the compensation in lieu of a deduction the value of money the credit allowed by § 1341(a) in the year 2013 of repayment would be equivalent to the tax that was paid on the recharacterized profits in 2011. If John or Kenny’s tax rate in the year 2011 was more than it is in year 2013, the credit would yield more tax savings than a deduction. The credit method might be particularly attractive to John for the reason that he is now retired and most probably facing a much lesser tax rate in the year 2013.

To meet the criteria for the credit, the sum of deduction accessible on repayment must exceed $3,000 and the taxpayer must show that

• She or he had an unrestricted right to the sum or value in question in the year of receipt and
• It was later established that the taxpayer did not have that unrestricted right.

In a case with facts or truth nearly identical to those in the current condition,

Van Cleave v. U.S., 83-2 USTC ¶9620, 52 AFTR2d 83-6071, 718 F.2d 193 (CA-6, 1983),