Question

Pink Corporation has several employees. Their names and salaries are listed below:

Judy $470,000

Holly (Judy's daughter) 100,000

Terry (Judy's son) 100,000

Amman (an unrelated third party) 320,000

Holly and Terry are the only shareholders of Pink. Judy and Amman share equally in the management of the company's operations. Holly and Terry are both full-time college students at a university 200 miles away. Pink has substantial E & P and never has distributed a dividend. What are any income tax issues related to Pink's salary arrangement?

Answer 1

Holly, Terry and Judy's salaries might be considered as unreasonable and treated as constructive dividend and not a salary expense for Pink and therefore might not be deductible by the Pink corporation, due to the following reasons:

Holly and Terry: Both of them does not seem to by earning the $100,000 each salaries paid to them by the corporation, since they are full time students at a  university 200 miles away, they possibly do not sufficient proof of rendering services to the corporation.

Judy: Judy although is not a shareholder of the company, but her relationship with Holly and Terry might result in his salary paid in excess of Amman, being considered under the perview of unreasonable compensation. Since Judy and Amman share equally in management, Jusy's salary in excess of Amman's salary does nto seem reasonable.

Also, considering the fact that inspite of substantial E & P, Pink has never distributed any dividend, might also result in their salaries being considered as being unreasonable and treated as constructive dividend.