BUS 599 Tax Research and Recommendations Paper Example
BUS 599 Tax Research and Recommendations Paper Assignment Brief
Assignment Instructions Overview
This assignment requires the preparation of a professional client letter that addresses key issues identified by the Internal Revenue Service (IRS) during an examination. The focus will be on three areas of tax law and practice: compensation reasonableness, stock redemptions, and rental losses. Students will analyze relevant provisions of the Internal Revenue Code (IRC), particularly Sections 162(a), 301, and 302, and apply these principles to create well-supported recommendations. The assignment emphasizes ethical and strategic tax planning while ensuring compliance with federal tax regulations.
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Understanding Assignment Objectives
The purpose of this assignment is to strengthen students’ ability to apply U.S. tax law in real-world scenarios. Students will demonstrate their understanding of reasonable versus unreasonable compensation under Section 162(a), evaluate the tax treatment of stock redemptions under Section 301, and design a strategic tax plan that reflects compliance and efficiency. In addition, students will explore estate and gift tax considerations, including the role of irrevocable trusts, and propose ethical strategies to minimize tax burdens on future property transfers.
The Student’s Role
Students will assume the role of a Certified Public Accountant (CPA) representing a client currently under IRS examination. As the client’s advisor, the student must interpret tax regulations, assess risks, and recommend strategies that balance compliance with legitimate tax minimization. The role requires providing clear, well-researched, and ethically grounded guidance in the format of a professional client letter.
Competencies Measured
This assignment measures the following competencies:
- Application of Tax Law – Demonstrating knowledge of relevant IRC sections and their implications for business owners.
- Analytical Reasoning – Evaluating tax treatment in complex situations such as compensation disputes and stock redemptions.
- Tax Planning and Strategy – Designing strategies that are both compliant and advantageous to the client’s long-term financial position.
- Ethical Decision-Making – Recommending approaches that reduce tax liability without engaging in misconduct or aggressive avoidance.
- Professional Communication – Presenting findings in a client letter format that is clear, precise, and professionally appropriate.
BUS 599 Tax Research and Recommendations Paper Example
[Date]
[Client’s Name]
[Client’s Address]
[City, State, Zip Code]
Re: IRS Examination – Proposed Adjustments and Tax Planning Recommendations
Dear [Client’s Name],
This correspondence provides a comprehensive review and recommendations regarding the recent Notice of Proposed Adjustments (NPA) issued by the Internal Revenue Service (IRS) concerning your building supply and warehousing business. The NPA identifies three principal issues: (1) unreasonable compensation, (2) stock redemptions, and (3) a rental loss. Each issue carries significant implications for tax liability, compliance, and long-term business planning. This letter addresses these matters in detail and provides ethical and legally sound tax planning strategies that align with the Internal Revenue Code (IRC). The objective is to position your case effectively during the IRS examination while ensuring sustainable tax practices for your business and family.
- Reasonable versus Unreasonable Compensation (IRC Section 162(a))
Understanding Reasonable Compensation
The Internal Revenue Code Section 162(a) permits businesses to deduct “a reasonable allowance for salaries or other compensation for personal services actually rendered.” This provision allows legitimate deductions for compensation, provided that the payment reflects genuine services and not disguised profit distributions.
The IRS applies several tests to assess whether compensation is reasonable:
- Role and Responsibilities – The duties performed, the level of authority, and the value of contributions to the business must justify the salary. For instance, as president and majority shareholder, your leadership, decision-making, and strategic oversight warrant higher compensation compared to non-executive roles.
- Comparison with Industry Standards – Compensation must align with salaries paid for similar positions in comparable companies. Excessive deviation from industry benchmarks may raise IRS scrutiny.
- Company Size and Performance – Larger businesses with higher revenues can justify higher salaries. Conversely, if profitability does not support high compensation, the IRS may consider a portion of the salary unreasonable.
- Economic Conditions – Market conditions, such as downturns or recessions, influence the appropriateness of compensation levels.
- Nature of Services – Compensation must correlate with actual services performed, rather than reflecting shareholder status alone.
Indicators of Unreasonable Compensation
Unreasonable compensation typically arises when salaries significantly exceed industry norms without evidence of corresponding duties or performance. For example, if your compensation is disproportionately high compared to executives in similar supply businesses, the IRS may reclassify a portion as nondeductible dividends rather than deductible wages.
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Example in This Case
If your current salary as president far exceeds industry averages without showing proportionate business growth or operational responsibility, the IRS may disallow a portion. Conversely, establishing your salary through benchmarking studies, board approval, and periodic performance reviews would support reasonableness. This evidence-based approach strengthens the defense that compensation reflects genuine business needs and services rendered.
- Stock Redemptions (IRC Sections 301 and 302)
IRS Position under Section 301
The IRS has treated the redemption of your stock and your son’s stock in the construction company as a distribution under IRC Section 301. This classification results in dividend treatment, which is less favorable than capital gains treatment.
Section 301 governs corporate distributions of property to shareholders. If a redemption does not meaningfully change ownership interests, the IRS views it as equivalent to a dividend, thereby subjecting it to ordinary income tax rather than capital gains tax.
Taxable Redemption (Dividend Treatment)
A redemption is taxable as a dividend when there is no substantial reduction in the shareholder’s proportionate interest. In your case, both you and your son retained equal ownership (50% each) after the redemption. Since no meaningful shift in ownership occurred, the IRS correctly categorized it as a distribution under Section 301.
Example:
If a shareholder owns 60% of a company and redeems 10% of stock, retaining 50% ownership, the IRS will likely view this as a dividend distribution because control and proportion remain intact.
Non-Taxable Redemption (Capital Gains Treatment)
A redemption may qualify as a sale or exchange under Section 302 if it substantially changes ownership or results in complete termination of interest. Such treatment allows taxation at capital gains rates.
Example in Scenario Context:
Had you redeemed a portion of your shares such that your ownership decreased substantially (e.g., from 70% to 40%), Section 302 may have applied, enabling favorable capital gains treatment. Alternatively, if your son retained all stock while your ownership was completely terminated, the redemption would not be treated as a dividend.
Strategic Implications
Understanding this distinction is vital in planning future stock transactions. Structuring redemptions to trigger “substantially disproportionate” ownership changes can yield lower tax burdens and more efficient estate planning outcomes.
- Tax Planning Strategies Using IRC Section 301
Balancing Compensation and Distributions
Strategic tax planning requires balancing reasonable salaries with dividends. Excessive compensation risks disallowance, while excessive dividends may increase personal income tax liability. A carefully designed compensation policy that combines salary, performance bonuses, and dividends can optimize overall tax efficiency.
Reinvesting Profits
Rather than paying excessive distributions, reinvesting profits into business growth initiatives, asset acquisitions, or employee development may reduce immediate tax liabilities while enhancing long-term profitability.
Structuring Redemptions for Capital Gains
When planning stock redemptions, it is prudent to design transactions that qualify under Section 302 to achieve capital gains treatment. This requires demonstrating meaningful ownership reduction or complete termination of interest.
Retirement and Tax-Deferred Vehicles
Maximizing contributions to retirement accounts such as 401(k)s, SEP IRAs, or defined benefit plans reduces taxable income while securing future financial stability. These vehicles also demonstrate compliance with compensation reasonableness tests by tying benefits to long-term service.
- Multiple Sources of Compensation – Ethical Strategies
Diversifying compensation sources minimizes tax risk and provides financial security. Ethical strategies include:
- Performance-Based Bonuses – Linking bonuses to measurable business outcomes justifies additional compensation while remaining IRS-compliant.
- Deferred Compensation Plans – Deferring income to future years spreads tax liability and aligns with long-term planning.
- Equity-Based Compensation – Stock options or profit-sharing plans allow wealth accumulation without immediate tax burdens.
- Retirement Contributions – Employer-sponsored retirement contributions provide tax deductions for the business while securing benefits for the individual.
- Fringe Benefits – Offering health insurance, education assistance, or wellness programs provides non-taxable benefits while supporting employee welfare.
This approach demonstrates transparency, ethical conduct, and adherence to tax law while optimizing financial outcomes.
- Effect of an Irrevocable Trust on Gift and Estate Taxes
An irrevocable trust is an effective tool for shielding assets from estate taxes. Once assets are transferred to such a trust, they are removed from the taxable estate, thereby reducing estate tax liability.
Key Benefits:
- Gift Tax Efficiency – Transferring interests into an irrevocable trust can utilize the annual gift tax exclusion and lifetime exemption.
- Estate Tax Reduction – Assets in the trust are excluded from the estate, lowering the taxable value.
- Asset Protection – Trust assets are safeguarded from creditors and preserved for beneficiaries.
Example Application:
Transferring part of your business interest into an irrevocable trust benefits heirs while reducing the estate’s taxable value. The trust can also be structured to allow income distributions for family support, thereby balancing asset protection with flexibility.
- Ethical Estate and Gift Tax Reduction Strategies
To reduce estate and gift taxes ethically, consider the following approaches:
- Annual Gift Exclusion – Transfer up to $18,000 per recipient annually (2024 limit), free from gift tax. This allows gradual wealth transfer without incurring tax liability.
- Lifetime Gift and Estate Exemption – Leverage the $13.61 million lifetime exemption (2024 figure), ensuring substantial assets can be transferred tax-free during life or at death.
- Family Limited Partnerships (FLPs) – Transfer business interests to family members at discounted values while retaining management control. This reduces estate tax while keeping business oversight centralized.
- Charitable Giving – Donations to qualified charities reduce taxable estate value and generate income tax deductions.
- Generation-Skipping Transfers – Trust structures can allow assets to pass directly to grandchildren, minimizing estate tax exposure across generations.
These strategies demonstrate ethical compliance with IRS provisions while ensuring wealth preservation for future generations.
Conclusion
The IRS examination highlights three critical issues requiring careful response: compensation practices, stock redemption classification, and rental losses. By ensuring compensation aligns with IRC Section 162(a), structuring redemptions to achieve favorable tax treatment under Sections 301 and 302, diversifying compensation ethically, and employing irrevocable trusts for estate planning, the business can address current IRS concerns while strengthening long-term financial health.
These recommendations prioritize compliance, ethical conduct, and sustainable tax planning. Implementing them will mitigate IRS scrutiny, reduce immediate tax burdens, and protect family wealth across generations.
Please feel free to reach out for additional clarification or to discuss the implementation of these strategies.
Sincerely,
[Your Name]
[Your Title]
[Your CPA Firm]
[Contact Information]
References
Agostino, F., & Nazario, V. (2018). Reporting transfers from US taxpayers to foreign corporations – IRS Form 926. SSRN Electronic Journal. https://doi.org/10.2139/ssrn.3256874
Findlaw. (2023). 26 U.S.C. § 301 – U.S. Code Title 26. Internal Revenue Code § 301. http://codes.lp.findlaw.com/uscode/26/A/1/C/I/A/301
Tax Notes. (2024). IRC section 302 (distributions in redemption of stock). Tax News, Tax Articles and Information. https://www.taxnotes.com/research/federal/usc26/302
Woodlock, P., & Liu, S. (2018). The influence of Internal Revenue Code section 162(M) on pay sensitivity estimates: The case of Section 162(m) qualifiers and non-qualifiers and the value of subjectivity in compensation arrangements. Universal Journal of Management, 6(9), 340–351. https://doi.org/10.13189/ujm.2018.060904
IRS. (2024). Estate and gift taxes. Internal Revenue Service. https://www.irs.gov/businesses/small-businesses-self-employed/estate-and-gift-taxes
IRS. (2023). Retirement plans for small businesses. Internal Revenue Service. https://www.irs.gov/retirement-plans
Detailed Assessment Instructions for the BUS 599 Tax Research and Recommendations Paper Assignment
Paper details
Overview
Suppose you are a CPA hired to represent a client who is currently under examination by the IRS. The client is the president and 95% shareholder of a building supply sales and warehousing business. He also owns 50% of the stock of a construction company. The client’s son owns the remaining 50% of the construction company’s stock. The client has received a notice of proposed adjustments (NPA) on three significant issues related to the building supply business for the years under examination.
The issues identified in the NPA are unreasonable compensation, stock redemptions, and a rental loss. Additional facts regarding the issues are reflected below:
Stock redemptions: During the audit period, the construction company redeemed 50% of the outstanding stock owned by the client and 50% of the stock owned by the client’s son, leaving each with the same ownership percentage of 50%.
The IRS treated the redemption as a distribution under IRC Section 301.
Instructions
Write a 4-5-page explanation, following the client letter format, in which you:
Determine reasonable versus unreasonable compensation as outlined in the IRS 162(a) law.
Establish when stock redemption is taxable and when it is not. Provide an example of each situation as it relates to the assignment scenario.
Create a tax plan. Use Section 301 of the IRC.
Develop a research-based and ethical strategy for the client to receive multiple sources of compensation without getting penalized with taxes.
Assess the effect of an irrevocable trust on the gift tax and future estate taxes.
Propose ethical suggestions to reduce estate tax and gift taxes on property transfers.
Use at least three resources to support your research or recommendations.
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