Question

Mr. and Mrs. Williams own 100% of Lessing, Inc., a regular corporation (i.e. not an S-Corporation). Mr. and Mrs. Williams work at the company and the corporation pays each of them a reasonable salary for their efforts.

Last year, they employed their 19-year old son to work for the corporation, paying him a salary of $75,000. During a recent IRS audit, the IRS revenue agent determined that the son rarely shows up for work and spends most of his time playing golf.

Ignoring payroll tax implications, what are the most likely potential tax implications of this discovery to Mr. and Mrs. Williams.

Answer 1

As per the rules of IRS, a business can claim deduction for salaries paid to children (in this case son) only if they have actually worked for the company during the year. In the given case, the business expense claimed with respect to son's salary expense will be disallowed to the extent it is unreasonable. Further, if there is no active involvement of the son in the business and the same gets established by the IRS audit, the salary paid to son will not be treated as a business expense, which in turn will increase the corporation's taxable income. This would increase the tax liability of the corporation. An increase in business income will also cause an increase in amount that will be distributed to Mr. and Mrs. Williams and will also result in an increase in personal tax liability for both of them as regular corporations are subject to double taxation (at the corporate level and at the personal level.