## Facts

- Terry J. Welle was president and sole shareholder of Terry Welle Construction, Inc. (TWC), a C corporation specializing in construction, with typical job profit margins of 6%–7%.
- The Welles built a lakefront home beginning in 2004 and used TWC to open a “cost plus” job account to track and pay project invoices.
- The Welles personally selected and dealt with subcontractors and vendors and acted as their own general contractors.
- Subcontractors and vendors billed TWC; TWC paid invoices and tracked costs. TWC’s framing crew performed framing work on the home.
- The Welles fully reimbursed TWC for all direct materials and labor costs and an allocation of overhead, but paid no additional amount for TWC’s usual profit margin.
- The IRS treated the uncharged profit component as “forgone profit” of $48,275 and determined it was a constructive dividend to Mr. Welle for 2006.
- The IRS issued a notice of deficiency for 2006 asserting a $10,620 income tax deficiency and a $2,124 accuracy-related penalty under I.R.C. § 6662(a).

## Issues

1. Whether Mr. Welle received a constructive dividend in 2006 equal to TWC’s alleged forgone profit of $48,275 from services connected to construction of the Welles’ home.
2. Whether the Welles were liable for the accuracy-related penalty under I.R.C. § 6662(a) for 2006.

## Decision

- The Tax Court held no constructive dividend occurred because the arrangement did not constitute a distribution of TWC’s current or accumulated earnings and profits.
- The court found no diversion of corporate assets or diminution of TWC’s net worth where the Welles reimbursed all costs and overhead.
- The court rejected the IRS theory that mere foregone profit, without an uncompensated corporate outlay or transfer of value, is a constructive dividend.
- Because the constructive-dividend adjustment was disallowed, the court held the Welles were not liable for the § 6662(a) penalty.

## Legal Principles

- A dividend requires a distribution of property by a corporation to a shareholder out of earnings and profits. I.R.C. §§ 301, 316, 317.
- A constructive dividend generally requires an economic benefit conferred on a shareholder that reflects a diversion of corporate assets and a corresponding reduction in corporate net worth without expectation of repayment.
- A corporation’s provision of services to a shareholder at cost, where the shareholder fully reimburses the corporation for direct costs and overhead, does not by itself create a constructive dividend merely because the corporation did not charge its customary profit margin.
- An accuracy-related penalty under I.R.C. § 6662(a) depends on an underpayment; absent a deficiency, the penalty does not apply.

## Conclusion

The Tax Court held that TWC’s at-cost involvement in building its sole shareholder’s home did not produce a constructive dividend where the shareholder reimbursed all costs and overhead, and it therefore sustained no deficiency or accuracy-related penalty for 2006 on that theory.


Welle v. Commissioner, 140 T.C. 420 (2013)