Welle v. Commissioner
140 T.C. No. 19, 140 T.C. 420, 2013 U.S. Tax Ct. LEXIS 20 (2013)
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Rule of Law:
A corporation's provision of services to its sole shareholder at cost does not create a constructive dividend equal to the corporation's forgone profit, provided the shareholder fully reimburses the corporation for all direct and indirect costs, because such a transaction does not divert corporate assets or reduce the corporation's earnings and profits.
Facts:
- Terry J. Welle was the president and sole shareholder of Terry Welle Construction, Inc. (TWC), a company specializing in multifamily housing projects.
- The Welles decided to build a second home on their lakefront property in Minnesota.
- The Welles acted as their own general contractors, personally contacting and managing all subcontractors and vendors for the construction of their home.
- During the construction, TWC paid the subcontractors and vendors directly on behalf of the Welles.
- TWC's framing crew performed the framing work on the Welles' new home.
- The Welles repaid TWC for all amounts it had paid to subcontractors and vendors.
- The Welles also fully reimbursed TWC for its own labor and overhead costs related to the project.
- TWC did not charge the Welles its customary profit margin of 6% to 7%, which it typically charged to its unrelated clients.
Procedural Posture:
- The Commissioner of Internal Revenue (respondent) determined a federal income tax deficiency of $10,620 for petitioners' 2006 tax year.
- The Commissioner also asserted an accuracy-related penalty of $2,124 under section 6662(a).
- The Welles (petitioners) challenged the determination by petitioning the U.S. Tax Court for a redetermination of the deficiency and penalty.
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Issue:
Does a sole shareholder receive a constructive dividend equal to the corporation's customary profit margin when the shareholder's wholly-owned corporation provides services for the shareholder's personal project at cost, and the shareholder fully reimburses the corporation for all associated direct and overhead costs?
Opinions:
Majority - Marvel, Judge
No. A shareholder does not receive a constructive dividend for forgone corporate profit when the corporation provides services at cost and is fully reimbursed. For a constructive dividend to exist, a corporation must confer an economic benefit on a shareholder that constitutes a distribution of its earnings and profits. The crucial concept is the diversion of corporate assets for the shareholder's benefit without expectation of repayment. Here, because Terry Welle fully reimbursed TWC for all costs, including overhead, there was no diversion of corporate assets or diminution of the corporation's net worth. The court distinguished this situation from a bargain sale of corporate property, where an existing asset is transferred for less than fair market value, thereby reducing corporate assets. A corporation's decision not to realize a potential profit on services provided to a fully reimbursing shareholder is not a distribution of property under section 316(a).
Analysis:
This decision provides a significant clarification on the constructive dividend doctrine for closely held corporations. It establishes a clear distinction between the distribution of existing corporate assets (which is taxable) and the mere forbearance from earning potential profit from a shareholder (which is not, if costs are covered). This ruling creates a safe harbor for shareholders who use their corporation's services for personal benefit, so long as they scrupulously reimburse all associated costs, including overhead. The case underscores that the foundational requirement for a dividend is a reduction in the corporation's earnings and profits, a test that is not met when a transaction is cost-neutral to the corporation.
