Chapter 12, Problem 16AP

In 1994, Mr. and Mrs. Adams formed ADC by transferring $50,000 cash in exchange for 100 shares of common stock and a note from the corporation for $49,000. The note obligated ADC to pay 10 percent annual interest and to repay the $49,000 principal on demand. ADC has never declared a dividend or made any interest payments on the note. Last year, it distributed $25,000 cash to Mr. and Mrs. Adams as a principal repayment. When the IRS audited ADC’s tax return, the revenue agent determined that this payment was a constructive dividend.

1. a. If ADC’s marginal tax rate last year was 34 percent, calculate any increase or decrease in ADC’s tax as a result of this constructive dividend.
2. b. If Mr. and Mrs. Adam’s marginal tax rate is 35 percent, calculate any increase or decrease in their tax as a result of this constructive dividend.