Kirby and his wife Melinda own all of the stock of Thrush. Melinda is the presid
ID: 2502307 • Letter: K
Question
Kirby and his wife Melinda own all of the stock of Thrush. Melinda is the president, and Kirby is the vice president. Melinda and Kirby are paid salaries of $500,000 and $350,000, respectively, each year. They consider the salaries to be reasonable based on a comparison of salaries paid for comparable positions
in comparable companies. The project Thrush's taxable income for next year, before their salaries, to be $975,000. They decide to place their three teenage children on the payroll and to pay them total salaries of $125,000. The children will each work about five hours per week for Thrush.
A. What are Kirby and Melinda trying to achieve by hiring the children?
B. Calculate the tax consequences on Thrush and on Kirby and Melinda's family of hiring the children.
Explanation / Answer
a. Kirby and Melinda are trying to use the salaries to reduce the taxable income of Thrush to zero ($975,000 - $500,000 - $350,000 - $125,000). By so doing, they can avoid the potential for double taxation.
b. If the salaries paid to the children are deemed reasonable, Thrush's taxable income is reduced to zero. Each child will report gross income of $41,667.
The more likely result is that a substantial portion of the $125,000 salary payments will be labeled as unreasonable compensation. In this case, Thrush's taxable income will be increased by the amount of unreasonable compensation. Each of the children will report gross income equal to the amount labeled reasonable compensation. Kirby and Melinda will have additional dividend income equal to the amount of the unreasonable compensation.
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