Question

1. Why do corporations disguise dividends? How does the IRS know you are disguising dividends?

Answer 1

Solution: Availing Payment deduction of excess paid amount is the only reason for this. The disguise dividend is an undeclared dividend, these payment are considered dividend and are taxable. In such setting, the shareholders are likely to consider the combined taxes to be paid by the corporation and themselves rather than just the tax they pay individually.

For examples: Unreasonable compensation, Loan from shareholder at unreasonable higher int. rate, Bargain sale to shareholders etc.

For recognizing the construction dividend/ disguised dividends, IRS usually checks out the factors which include individual's duties and responsibilities, what individuals are performing in comparable capacities at other corp. are paid, whether corp. has a formal compensation policy, and what the individual's return on his investment is as shareholder of the company.