Big Star Auto regularly advertises on local television. Carla, the owner of Big Star pays her 6-year-old grandson $250 for each commercial in which he appears for Big Star. During the current year, the grandson appeared in 100 commercials. Big Star wants to deduct the full $25,000 as a business expense. The grandson will report the $25,000 as income. Write a letter to Carla explaining whether Big Star can deduct the advertising fee paid to her grandson.
Advertising expense qualifies as an ordinary and necessary business expense of a car dealer. However, the transactions between Big Star and the grandson are subject to special scrutiny because they are related parties.
Was the transaction between Big Star and the owner’s grandson negotiated at arm’s-length and in fact, a payment for grandson’s services? If the fee was not actually paid for the grandson’s services, the expense is not deductible.
Was the payment reasonable in amount? If the payment was not reasonable in amount, it will also fail the ordinary and necessary tests. As a result, only the part of the fee that is determined to be reasonable will be allowed as a deduction. The reasonableness of the payments is determined by comparing the fees paid to other actors appearing in similar commercials.
