Wooden Boats amp; Woodcraft, Inc. was formed in 1990. It sells machinery, tools, kits, and supplies to woodworkers, professional and hobby.

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Wooden Boats & Woodcraft, Inc. was formed in 1990. It sells machinery, tools, kits, and supplies to woodworkers, professional and hobby. J. Gibbs owns 80% of the stock and his brother Duckie owns 20%. J is the president and works every day. Duckie is retired but sits on the board of directors. J’s spouse, JJ is a physical therapist and is not employed by WBW.

Over time WBW expanded from a single store in Michigan to several retail stores in Michigan, Illinois and Wisconsin. In 2014 WBW acquired NCIS competitor with stores in Arizona, Nevada, and Utah. WBW retained NCIS’ administrative office in Henderson NV, 10 miles outside of Las Vegas.

J’s current salary is $180,000. It was last set at this rate in 2010. He receives a bonus based on a formula adopted in 1992. The same formula applied to Duckie when he was employed. A similar formula is used for other officers, at a lower percentage.

WBW’s headquarters is located in Bad Axe, Michigan. The corporation rents the headquarters building from JJ Gibbs’ LLC at fair market rent. It is a triple net lease requiring WBW to pay all costs of repair and maintenance other than the roof, structural issues, and heating/cooling system. WBW owns all Michigan and Illinois stores. All other stores and the Henderson business office are leased from unrelated bona fide third parties.

The IRS audited WBW’s 2016 Form 1120. The agent has disallowed the following:

Painting expenses. Painte Me Contractors painted the exteriors of 4 Michigan stores ($100,000 for all), the headquarters building ($18,000), and a rental property J owns ($10,000).

The IRS disallowed $128,000 and treating it all as a constructive dividend.

Real Estate Taxes. WBW paid the property taxes on the headquarters as required under the lease. The IRS disallowed all $35,000, treating it all as a constructive dividend.

Charter Jet Expenses. WBW uses a private jet for travel. J makes quarterly trips to the Henderson office. On all 4 trips friends and

family travelled with him. They did whatever and he worked. He did play a round of golf, had a few dinners with family and friends, and attended one show each visit. The cost of each trip was $7,500. All 30,000 disallowed and treated as a constructive dividend

Disallowance of bonus. WDW paid J a bonus of $11,000,000 following the formula. Prior year bonuses: 4,500,000 in 2015, 0 in 2014, and 2,600,000 in 2013. 2017’s bonus was 6,500,000. WDW presented numerous studies that J’s salary has been 200,000-250,000 below the industry average for similar sized businesses since 2010.

All 11,000,000 was disallowed and charged as a constructive dividend.

Disallowance of Interest. J loaned WDW $1,000,000. The note calls for interest only payments. It bears interest at 3.5% (1% above the AFR at date of issuance). Prime rates were 7% in 2016, 5.75% in 2015, 5.5% in 2014, and 6.1% in 2017. Do not worry about the 7872 rules. The IRS imposed a constructive dividend of $35,000 the difference between the paid interest and the prime interest.

WDW needs advice as to the accuracy of the issues, the amount of constructive dividends (if any) and the tax treatment on the 1120 and Gibbs’ 2016 1040. You will need support for your answers – code sections, applicable regulations, rulings and cases. HINTS: Each item has an error. Some items may be partially correct. Also the agent has mistakenly applied rules.

Analysis so Gibbs and the IRS will understand. This analysis will be incorporated into the Appeal Protest objecting to the audit findings. There is no specific length. Identify the rule/law, apply it to the facts, and develop a conclusion.

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