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Research Problem – One

(Tax File Memo: 50 points)

Kenny Merinoff and his son, John, own all of the outstanding stock of Flamingo Corporation. 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 adopted 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 are 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 the collection of each such amount.

In 2013, Flamingo paid Kenny $800,000 in compensation. John received $650,000. As part of 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 are treated for Federal income tax purposes. John still is working as a highly compensated executive for Flamingo, while Kenny is retired and living off his savings. Prepare a memo for your firm’s tax research files describing the results of your review. In this memo, be sure to state clearly, and discuss, 1) the facts, 2) the issues, and 3) analysis and discussion sections. Citations are important.

Research Problem – Two

(Tax File Memo: 50 points)

Ken and Mary Blough, your neighbors, have asked you for advice after receiving correspondence in the mail from the IRS. You learn that the IRS is asking for documentation in support of the itemized deductions the Bloughs claimed on a recent tax return. The Bloughs tell you that their income in the year of question was $75,000. Because their record-keeping habits are poor, they felt justified in claiming itemized deductions equal to the amounts that represent the average claimed by other taxpayers in their income bracket. These averages are calculated and reported by the IRS annually based on actual returns filed in an earlier year. Accordingly, they claimed medical expenses of $7,102 taxes of $6,050, interest of $10,659 and charitable contributions of $2,693. What advice do you plan to give the Bloughs?

The response to the questions should include, 1) tax implications, 2) importance of Cheryl L. Werff Summary Opinion, and 3) Recommendations.

Research Aid: Cheryl L. de Werff, TC Summary Opinion, 2011 - 29

Computational Exercise (40 points)

Lisbeth makes the following interest-free loans during the year. The relevant Federal interest rate is 5 percent, and none of the loans are motivated by tax avoidance. All of the loans were outstanding for the last six months of the tax year. Identify the Federal income tax effects of these loans. Note carefully the tax position on each borrower which you should clearly identify and include discussions on, 1) the differences between imputed interest and market interest on gift loans, 2) the importance of loans between individual and, 3) the tax recognition of interest income.

Borrower	Amount	Borrower’s Other Net Investment Income	Purpose of Loan
Richard	$5,000	$800	Gift
Woody	8,000	600	Stock purchase
Irene	105,000	0	Purchase principal residence