Kenny Merinoff and his son, John, own all outstanding stock of Flamingo Corporat
ID: 2426818 • Letter: K
Question
Kenny Merinoff and his son, John, own all outstanding stock of Flamingo Corporation. Both John and Kenny are officers in the corporation and, together with their uncle, Ira, comprise the entire board of directors. Flamingo uses the cash method of accounting and has a calendar year-end. In late 2008, 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 2013, Flamingo paid Kenny $800,000 in compensation. John received $650,000. On an audit in late 2014, 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 2015. 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 describing the results of your research.
Explanation / Answer
MEMO FROM FLAMINGO CORPORATION
To ,
Mr. Casey Smith
From ,
John Peter
Date : 24/2/2016
Subject : Details research of internal issue of the directors at Flamingo Corporation
Dear sir,
With reference to above subject I would like to share the research memo with you.
Flamingo is a corporate company formed as per the corporation act in 2008. It is started by Mr. Kenny Merinoff and his son together with their uncle ,Ira with consist of entire board of directors . Mr Kenny and his son own all outstanding stock of Flamingo Corporation.
As per the board of directors, at the time of the formation of the corporation decided about how to run the business, about corporate structure , profit and loss sharing , remuneration as per the rules of the corporation act , which is agreed and signed by all the board of directors as per the articles of corporation.
And the Corporation started its operation by opening its separate bank account, started its minutes books for corporation meetings, board directors meeting, maintained cash method of accounting, has a calendar year end , etc,
After a couple of years the director of Flamingo corporation adopted legally enforceable resolution for the following reason,
The salary payment of an officer in the corporation to be disallowed in whole or part for which they treated as deductible expenses for income tax purpose. And which is against the articles of corporation. And in a meeting of board of directors decided that the officer compelled to reimburse the amount at the full extent.
In 2013, Flamingo corporation paid $ 8,00,000 and to John $ 6,50,000 compensation. As per the corporation act the yearly auditing stated that is for 2014, as per the IRS report it is found that the Mr. Kenny and Mr. John paid excessive compensation in the year 2013 that is # 4,00,000 for Mr Kenny and $3,50,000 for Mr. John. IRS treated the excessive compensation paid as constructive dividends for the tax purpose .
And as per the resolution by the board of directors both Kenny and john repaid the excess compensation to the corporation in the year 2015.
For tax purpose and to show the entry in the books of account that is before the year ending , the excess amount paid treated as a loan given to Mr. Kenny and Mr. John and repaid amount to be entered as loan repaid in flamingo account and Mr. John and Mr. Kenny account and to make sure that amount be disclosed all the books of account
As per the rule if a payment is made to a director and it does not form part of the director’s remuneration package or is not an allowable expense for the company, the payment must be set against their director’s loan account. If the director has a balance available on their director’s loan account, then the director can merrily set such a payment against their loan account with no tax implications.
Thanking you
With refgards,
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