Graham is the sole shareholder of Logan Corporation. For the past five years, Logan has reported little or no taxable income, as a result of paying Graham a salary of $500,000 per year. During a recent IRS audit, the revenue agent determined that Graham’s educational and business experience, and his time devoted to managing Logan, justified a salary of only $200,000. Thus, the agent re-characterized $300,000 of the payments from the corporation as a dividend.
a. Calculate the additional income tax liability for Logan as a result of this constructive dividend treatment. (Ignore any payroll tax consequences.)
b. What are the tax consequences to Graham as a result of the constructive dividend treatment? Calculate the change in Graham’s income tax liability as a result of this change. Assume that Graham’s marginal tax rate on ordinary income is 39.6 percent. (Ignore any payroll tax consequences.)
c. Given your calculations, determine the total impact on Treasury tax collections as a result of this audit finding.