Recharacterized Distributions

[Snaggletooth]

Every so often I read where the IRS has recharacterized bonuses or loans and converted them to "dividends." How are other shareholders affected when this happened?

Example: Richie Rich is a 60% shareholder in Cee Corporation, and authorizes a bonus to himself of $300,000 payable on December 30th. Cee Corp's profits prior to the bonus were $360,000, and there have never been dividends declared. Richie Rich W-2 for 2009
reflects the extra $300,000 and all payroll taxes are properly withheld and paid.

Some few months before the expiration of the SOL, IRS acts to recharacterize this bonus as a dividend.

Is there any affect on the other 40% shareholders? I say no. Cee Corp has still never had a corporate resolution to declare dividends, and the IRS is for tax purposes only and not for book purposes. I maintain each of the following is true:

1. The bonus expense remains as recorded at $300,000 for 2009.
2. Retained earnings for all years up to the SOL remain unaffected.
3. The Corporate Income tax expense on the books remains unchanged
for 2009 and all years prior to the recharacterization.
4. Cee Corp has to pay $80,000 on the assessment. The extra $80,000
appears as corporate income tax expense in the year of assessment.
for book purposes.
5. No further changes are required on the M-1, allowing for the fact that the
additional tax will be reported on line 2, Federal Income Tax Expense.
6. No dividends to Richie Rich or any other shareholder are recorded on the
books of the corporation.

For anyone has cared to wade this far into this post, do you agree or disagree?
This is a good GAAP question (I think).

[Black Bart]

Hmm,

...do you agree or disagree?...

You may be right!

[JohnH]

Ron:
For what it's worth, I finished a lengthy audit earlier this year in which the corporation had two shareholders - one was active in the corp and the other was a parent who owned 25% as security for seed money provided when the corp started up. No actual dividends had ever been delcared or paid.

The active shareholder was tagged with SIGNIFCANT constructive dividends over a period of 3 years, with most of it coming from payments improperly classified as loans to the active shareholder only.

There was never any mention by the auditor of any consequence to the 25% shareholder. I think unequal payment of dividends might be an accounting issue, but not so important to the IRS. But this is based on only one experience.

[Maribeth]

About 10 years ago, my Cee Corp was audited for a bad debt deduction and during the audit, the issue of unreasonable compensation came up. About $100K of comp was recharacterized as dividends, along with another $50K or so of loans.

EVERYTHING was redone. The books were adjusted, the financial statements were redone, the payroll tax filings, everything.

This corporation had substantial bank debt. Audited or reviewed financial statements were NOT required by the bank, but quarterly full-disclosure compilations were. Like I said, everything was redone.

It may have been that the bank required the restatements. I cannot remember, but I do remember the work involved is adjusting everything.

Maribeth

[Zee]

Planning point

After reading this post, I did a little research do better understand the question and issues.
One of the articles I read, indicated that when the IRS reclassifies excessive compensation as a dividend, the IRS will generally not adjust the SH return because this will result in a refund, and believes that it is the taxpayer's responsibility to file a return for income. If this is true, be careful and watch the Statute of Limitations if your client is appealing such a reclassification to ensure an amended return is filed on time.