Provision of services by corporation to shareholder not a constructive dividend.

AuthorBeavers, James A.

The Tax Court held that the sole shareholder of a corporation did not receive a constructive dividend when the corporation provided construction services to the shareholder at cost.

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Background

TWC is a construction company that specializes in multifamily housing projects. Terry Welle is TWC's president and sole shareholder.

Welle owned lakefront property in Detroit Lakes, Minn., on which he decided to build a second home (the lakefront home). In 2004, Welle began construction of the lakefront home. To keep track of material and other construction costs, he caused TWC to open a "cost plus" job account on its books. Welle, however, contacted all of the subcontractors and building supply vendors that built or supplied materials for the lakefront home and acted as his own general contractor during its construction.

During construction, TWC paid the subcontractors and vendors directly, and its framing crew framed the lakefront home. Welle repaid TWC for all amounts paid to the subcontractors and also reimbursed TWC for its labor and overhead costs. TWC, however, did not charge Welle, and Welle did not pay to TWC, an amount equal to the customary profit margin that TWC used to calculate the contract price that it charged its unrelated clients (forgone profit).

The IRS determined that Welle received a constructive dividend of $48,275 from TWC in 2006, equal to the forgone profit on the construction services it provided to him. Welle challenged the IRS's determination in Tax Court.

Constructive Dividends

Under Sec. 61(a)(7), a taxpayer includes dividends in gross income. Sec. 316(a) defines a dividend as any distribution of property that a corporation makes to its shareholders out of its earnings and profits accumulated after Feb. 28, 1913, or out of its earnings and profits for the tax year. Under Sec. 317(a), property includes money, securities, and any other property except stock in the distributing corporation. Under some circumstances, the provision of services by a corporation to its shareholders constitutes property within the meaning of Sec. 317(a).

A constructive dividend occurs when a corporation confers an economic benefit on a shareholder without the expectation of repayment. Generally, the amount of a constructive dividend is measured by the fair market value (FMV) of the benefit conferred.

The Tax Court's Decision

The Tax Court held that Welle did not receive a constructive dividend when TWC provided him...

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