You are currently working at a mid - sized certified public accounting firm. You

Question

You are currently working at a mid - sized certified public accounting firm. Your client is Bob Jones. Bob, age 60 and single, has recently retired from IBM. He has $690,000 available in his 401(k) fund and he is thinking of using that money to open a used car business that will be located at 210 Ocean View Drive in Pensacola, Florida. Bob has estimated that the business might make $300,000 in taxable income. Bob’s personal wealth including investments in land, stocks, and bonds is about $14,000,000. He reported a n 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 Corporation. He is also considering transferring a possible 40% interest in his new business to his daughter Mandy, age 23 and single Please complete the following:. A. Accurately compute the property disposition capital gain and taxation of gross income. B. Explain whether the client and his child should take a salary or cash distribution according to tax purposes and the internal revenue code and treasury regulations. C. Identify the Tax Consequences on the sale or exchange of the land consistent with capital gains rules. Consider the selling expenses, broker fees, closing costs, appraisals, and surveys and the correct tax schedule form to complete.

Explanation / Answer

Ans;

Creative problem solving is as ancient concept as humans. It helps in problem solving and decision making if the 7 steps of CPS are properly followed.

CPS Steps

No. The sole proprietorship is a wrong choice. I would advice Bob jones to operate as a S corporation because of the tax benefits.

Simple Example
Here is a simple example. Let’s say you have two self-employed people, Sam and Carrie, who are both freelance photographers. Their businesses make the same net profits of $60,000 last year ($5,000/month). The only difference is that Sam is a Sole Proprietorship and Carrie is an S-Corporation.

Because Sam is a sole proprietorship, there is no difference between him and the business. They are one and the same. Therefore he has to pay self-employment taxes (Social Security + Medicare) of 15.3% on the entire $60,000 annual net profit, or about $9,200. He also must pay federal and local income taxes on that income.

Carrie is a bit different. She incorporated her one-person business into an S-Corporation, which is a separate entity. She wears two hats: she is the sole shareholder of that corporation, and also the sole employee.

S-Corporation are a ‘pass-through’ entity, which means all the profits of the corporation pass through directly to the shareholders’ tax returns. S-Corps do not pay corporate income taxes. However, the classification of this profit also matters:

As an employee, she just assigns herself a “reasonable salary” as required by the IRS. She does some research, and finds that similar photographers in her area earn $25 an hour. $25 an hour x 40 hours a week = $1000/week, or $4,000/month. So her salary is $4,000/month.

As the corporation shareholder, she owns a business with $5,000 of overall profits each month, but also pays out $4,000 for that one extremely loyal employee. That means $1,000 per month is not paid out as salary, and will be distributed to the shareholders (her) as dividends, or unearned income.

At tax time, Carrie gets $48,000 a year in earned income as an employee, and $12,000 in S-Corp distributions as a shareholder. You only pay self-employment taxes on earned income. $48,000 x 15.3% = $7,400. She also must pay federal and local income taxes, the same amount as Sam.

So as an S-Corporation, Carrie paid $1,800 a year less than Sam in taxes

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