I. Memorandum D. Explain the tax effect based on providing $180,000 per year for the client’s salary and $70,000 per year for his daughter’s salary if they withdraw cash from the business or pay dividends as appropriate. E. Justify the percentage of ownership the client’s daughter should have in the business based on the type of business entity recommended. Consider the tax law in reference to the recommendation and how the decision will affect the daughter’s tax return.
To explain the tax effect of providing salaries to the client and his daughter, as well as the justification for the daughter's percentage of ownership in the business, we need to understand the tax implications based on whether they withdraw cash from the business or pay dividends.
1. Salaries and Taxation:
When the client and his daughter receive salaries from the business, they are considered employees and will be subject to payroll taxes, such as Social Security and Medicare. The business will also bear the responsibility of paying employer-side payroll taxes.
The salaries provided to the client and his daughter will be deductible expenses for the business, which means they can reduce the taxable income of the business. However, the client and his daughter will have to report their salaries as taxable income on their personal tax returns. They will be liable for income tax based on their individual tax brackets.
2. Dividends and Taxation:
If the client and his daughter receive dividends instead of salaries, the tax implications can vary depending on the business entity recommended.
- C Corporation: If the business entity recommended is a C Corporation, dividends paid to shareholders are subject to double taxation. The corporation pays tax on its profits, and when dividends are distributed to shareholders, they are taxed on the dividend income as well. Dividends are not deductible for the corporation, so they are taxed at both the corporate level and the individual level.
- S Corporation or Partnership: If the recommended entity is an S Corporation or a Partnership, the business does not pay taxes at the entity level. Instead, profits and losses pass-through to the shareholders (in the case of an S Corporation) or partners (in the case of a Partnership). Dividends received by shareholders or partners are not subject to double taxation, as they are considered a return of capital or a share of the business's profits. They are typically taxed at the individual tax rates of the recipients.
3. Ownership Percentage and Tax Implication:
The justification for the daughter's percentage of ownership in the business should consider various factors, including her actual contribution to the business, her involvement in day-to-day operations, her qualifications, and the desired allocation of profits and control.
From a tax standpoint, if the daughter has a substantial ownership interest in the business, she may benefit from the business's profits and potentially have access to additional tax deductions, such as business expenses or losses. However, if the daughter's ownership percentage is high, the business may need to allocate a significant portion of its profits to her, which could result in higher taxes for both her and the business.
It is crucial to consult with a tax professional or a certified public accountant (CPA) who can evaluate the specific circumstances and objectives. They will be able to provide tax advice tailored to the client's situation and help determine the optimal ownership percentage considering both tax implications and other business factors.