Ashley and Betty run a very successful business with a high end celebrity hair salon, A & B’s Happy Hair, Inc. Ashley and Betty also own patents on special hair care products that they sell only through their salon for top dollar. Ashley & Betty are the only shareholders.
A & B’s Happy Hair is doing very well this year. They have a current earnings and profits of $750,000. Besides their long list of celebrity clients, part of the reason the company does so well is their extremely high margins. A one year supply of Happy Hair’s Full Care Elixir sells for $3,000. However, the product only costs the company $500. Even with such a high price, the product remains in constant demand and Ashley and Betty are continually restocking supplies.
Ashley’s son Jerry is graduating from high school this year. As a graduation gift, Ashley wants send her son on a trip to Europe for the summer. Ashley also plans to pay for her son’s college tuition. In total, Ashley needs $80,000.
Betty’s daughter, Wendy, is older than Jerry and will actually be graduating from college this year. Betty wants her daughter to live at home when she returns from college, but of course her daughter wants her own independence and privacy. To meet both of their desires, Betty wants to add on a “mother-in-law” suite to the family house so that Betty can have the peace of mind with Wendy at home, while Wendy will have the independence she desires. The cost of the remodel is $80,000. As a graduation gift, Betty wants to give Wendy a one year supply of Happy Hair’s Full Care Elixir. Betty obviously believes that since she is part owner, she should be able to buy the products at cost for $500 instead of the normal retail price of $3000. Ashley agrees that Betty should be able to buy the products at cost as well.
Because both Ashley and Betty are in need of funds, they each decide and agree to withdraw a total of $160,000 from the corporation.
Ashley and Betty assume there are different ways to structure the withdrawal but are not sure of what the differences are and what their options are. They came to your office seeking advice so they can make a sound decision, taking into account the tax implications of their actions.
Explain the tax consequences and various options that Ashley and Betty have.
Based upon the facts given, is there any other advice you would give to Ashley and Betty?