Kansas Corporation is a 68% shareholder in Colorado,Inc.Last year,Colorado paid Kansas $100,000 as compensation for unspecified services provided by Kansas employees to Colorado,and deducted the payment on its federal income tax return.The revenue agent who audited both corporations' returns concluded that the payment is a constructive dividend.Both corporations have a 34% marginal tax rate.What is the effect of this audit conclusion on each corporation's income tax liability?

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The payment being reclassified as a constructive dividend means it is not deductible for Colorado, increasing its taxable income by $100,000, leading to a $34,000 increase in tax liability (34% of $100,000). For Kansas, the $100,000 is now considered dividend income, which is typically taxed at a lower rate than ordinary income, resulting in a $27,200 decrease in tax liability (assuming the dividend tax rate is lower than the ordinary income tax rate).

Kansas Corporation Is a 68% Shareholder in Colorado,Inc