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.
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 determine the tax effect of providing salaries to the client and their daughter, as well as the percentage of ownership the daughter should have in the business, we need to consider various factors and reference the tax law. Let's break it down step by step.
1. Determining the Tax Effect of Providing Salaries:
To determine the tax effect, we need to consider the difference between withdrawing cash from the business and paying dividends. Both methods have different tax implications:
- Withdrawing Cash from the Business: If the client and their daughter choose to withdraw cash from the business as salaries, it will be subject to income tax for both of them. The salaries should be reasonable and comparable to what would be paid for similar services in an arm's length transaction, meaning the payment should be justified by the value of the services provided. The business will deduct the salaries as an expense, reducing its taxable income, and the client and daughter will include their respective salaries as taxable income on their personal tax returns.
- Paying Dividends: If the business decides to pay dividends instead of salaries, the dividends will be subject to dividend tax for both the client and daughter, depending on their individual tax brackets. Dividends are generally taxed at a lower rate than ordinary income, but tax laws might have specific rules regarding dividend taxation.
It is important to consult a tax professional or accountant to analyze the specific circumstances, tax laws, and regulations applicable to the client's situation to determine which option might be more tax-efficient.
2. Justifying the Percentage of Ownership for the Daughter:
The decision of the daughter's percentage of ownership depends on various factors, including the type of business entity recommended. Different types of entities have different tax implications:
- Sole Proprietorship or Partnership: If the recommended business entity is a sole proprietorship or partnership, the ownership percentage can be determined based on various factors such as capital contributions, involvement in business operations, or contribution to the business's success. However, keep in mind that the daughter's ownership percentage should accurately reflect her actual involvement and contribution to the business.
- Corporation: If the recommended business entity is a corporation, the ownership percentage can be determined based on the allocation of shares. The daughter's ownership percentage can be justified based on the amount of capital she invests in the business or by issuing shares to her that reflect her involvement and contribution.
It is crucial to consult legal and tax professionals to ensure compliance with relevant laws and regulations while determining the daughter's ownership percentage. Additionally, consider the impact on the daughter's tax return, as her ownership in the business will likely affect her tax liability, potential tax deductions, and eligibility for certain tax benefits.
In summary, analyzing the tax effects of providing salaries and determining the daughter's ownership percentage should be done in consultation with tax and legal professionals who have a comprehensive understanding of the client's specific situation and applicable tax laws.