Bob’s personal wealth including investments in land, stocks, and bonds is about
ID: 443848 • Letter: B
Question
Bob’s personal wealth including investments in land, stocks, and bonds is about $14,000,000. He reported an interest income of $20,000 and dividend income of $6,000 last year. The $14,000,000 includes land worth $9,000,000 that Bob bought in 1966 for $450,000.
Bob has hired your firm for professional advice regarding whether he should operate as a sole proprietor, a partnership, an S corporation, or a C corporation. He is also considering transferring a possible 40% interest in his new business to his daughter Mandy, age 23 and single.
Question: compute the property disposition capital gain and taxation of gross income for the client described in the final project. Based on your computations and relevant tax codes, explain the tax consequences on the possible sale or exchange of the land, including the impact on cash flow and salary or cash distributions.
Explanation / Answer
Ans:
Tax Consequences on the Possible Sale or Exchange of Property
The paper will seek to examine the tax consequences of the annual taxable income earned by Bob in his business operations. The computations and tax codes will provide relevant taxation insights on the business transactions such as the disposal of land at Bob’s business.
The property disposition capital gain can be computed as follows;
The capital gain on land
Current market value $ 9,000,000
Initial cost of land $450,000
Capital gain on land $8,550,000
Bob’s business would be classified as a sole proprietorship and thus is not a separate legal entity like in the case of corporation, limited liability companies and partnerships. It is recommendable for Bob’s business to report income earned in his personal tax return (IRS Form 1040) (Chong & Van der Linde, 2014). If the business earns profits, the income is added to other incomes including interest income and the total is taxed. In terms of taxation, Bob will be termed as self employed.
The taxation rates, which could be deductible from the annual income, include the total social security and Medicare tax including 12.4 per cent and 2.9 per cent respectively.
The total annual income includes the following;
Annual business income $300,000
Interest income $20,000
Dividend income $6,000
Total Taxable income $326,000
The tax rate that will apply is 15.3 per cent of $326,000= $49,878.
During the sale of the property, Publication 523 of the IRS indicates that if the business sales the property in exchange of cash, it will be taxed. The cash will be taxed as partial sales proceeds following the sales of Bob’s property, which could be generally classified as a capital gain (Roin, 2011). Under the current tax code, the long-term capital gains of individuals are taxed at a lower rate than the ordinary income.
Bob’s land qualified for long-term capital, as it had been held for more than 12 months, the maximum tax on long-term capital gains is 15 percent for qualifying taxpayers. However, certain assets are not eligible for capital gain treatment and the gains received on that property are treated as ordinary income and taxed at usual rate. Publication523 (2014) requires that the sale of land should be examined to confirm whether it qualified for any tax exclusion (Clark, 2013). Most of business expenses claims in their profit and loss section of tax return to lower the financial reportable income and thus, the income tax. This includes the continuing expenses such as telephone and on-ongoing items including training courses.
Taxation obligations have significant impacts on cash flow and profitability. Bob might be required to pay certain taxes and installments including pas as you go installments. The tax requirements for withholding the regular payments to meet the income tax demands. Such tax requirements would reduce the amount of cash flows maintained by the business (Gaertner, 2014). Therefore, the business should consider the consequences and implications of the taxes as well as understanding the computation of capital gains on land and the implications of cash flows.