Bright Corporation, an S corporation, has been 100% owned by Betty since its creation 12 years ago. The corporation has been profitable in recent years and, in the current year (assume a non-leap year), reports ordinary income of $240,000 after paying Betty a $60,000 salary. On January 1, Betty gifts 15% of her Bright stock to each of her three sons, John, Andrew, and Stephen, hoping they will work in the family business. Betty pays gift taxes on the transfers. The sons are ages 24, 17, and 15 at present and are not currently active in the business. Bright distributes $7,500 in cash to each son and $27,500 in cash to Betty in the current year.
a. What income does Betty, John, Andrew, and Stephen report for the current year as a result of Bright’s activities assuming the sons are considered bona fide owners of the stock? How will the income be taxed to the children?
b. Assuming the IRS determines a reasonable salary for Betty to be $120,000, how would your answer to Part a change?
c. How would your answer to Part a change if the sons were not considered bona fide owners of the stock?