The Property Disposition Capital Gains and Taxation of Gross Income
The computation of the gross income is from an individual's net revenue, where it comprises the addition of the interest, dividends, rent, salary, and all other sources of income before the application of taxes (Feld, Ruf, Schreiber, Todtenhaupt, & Voget, 2019). The calculations can also be from a business perspective where it includes the deductions of the total revenue from the cost of goods sold. Thus, Bob Jones’ gross income is:
Gr. Inc. = 14,000,000 + 300,000 + 20,000 + 6,000 = $14,326,000
The component of an investment’s total return that happens as an outcome in the increment of the market price of the property or security is the capital gain on the security or property (Rappaport, 2016). Using Bob Jones as an example, capital gains is the gradual increase in the cost of the property bought in 1996 but expressed in a percentage format. Thus, the capital gain from the disposition of the land is:
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Cap. G. = (cur. cost – Orig. cost) ÷ Orig. cost x 100
= (9,000,000 – 450,000) ÷ 450,000 * 100 = 19%
Therefore, gross income tax: The calculation involves the subtraction of the deductions from the gross income;
= $14,326,000 - $77,584 = $14,248,416
The Tax Consequences on the Sale or Exchange of the Land Consistent With Capital Gain Rules
The tax consequences on exchange or sale of the land consistent with capital gain rules can be best relayed through memorandum addressed to the client.
Memorandum Identifying Tax Implications
Date: 08/02/2020
From: Chris Brown
To: Bob Jones
Re: Response to Inquiry
Be aware that taxation of the proceeds from land sales is dependent on the consideration of whether the land is subject to a commercial transaction or a capital asset. Generally, land that lies vacant is a capital asset and thus, not exempted from capital gains tax. It comes as a relief that the land is in Florida, and the state has no property taxes on idle land (De Boer, Gill, Destremau, & Hensen, 2016). Therefore, no selling costs will be deducted from the selling price to meet the tax obligations. The deductions offer the value of sales taxable and might include such expenses as recording fees, deed registration taxes, transfer taxes, title insurance, title searches, as well as broker's commissions.
Local tax laws in Pensacola, Florida, offer discount rates for early payments of property tax while late payments attract a penalty. The penalties are enforceable 45 days after April 1 st every year, where the unpaid taxes become delinquent. A list of the defaulters is placed on advertisement where costs of the adverts are inclusive of the delinquent. The penalty draws a monthly interest rate of 1½% or 18% per annum (De Boer et al., 2016). Therefore, it is imperative for familiarization with the relevant tax laws as personal homes are subject to taxation, in case you consider constructing one. Since land does not depreciate, the depreciation cost on any improvements made on the property to increase its value is deductible from the charges to establish the basis of the asset.
The After-Tax Effects on the Client’s Cash Flow Based on the Sale of the Land
The after-tax cash flow (CFAT) is a financial tool that determines the financial performance that evaluates an organization’s capability to create cash flow through its commercial activities. The computation of the CFAT involves the addition of amortization, depreciation, and other non-cash costs to the net income (Blaufus & Hoffmann, 2019). From the data provided by the client, the CFAT computations will comprise the addition of the net income to the amortization as the land is vacant and, thus, cannot undergo depreciation and has no impairment charges.
CFAT = (Gross income-expenditure) + Amortization
= ($14,326,000 - $72,584) +$5,000 = $14,258,416
After tax effect: The after tax on Bob’s cash flow is $14,258,416, which means the impact of the tax on the client’s cash flow from the sale of the land will decrease. But, normalization for faster depreciation can lead to an increase in the cash flow after-tax. Normalization is the removal of non-recurring costs or income from a financial measurement to symbolize the capacity for future earnings that a prospect would expect from the enterprise.
Tax consequence: Even though the client is married and has a child of age 23, he cannot take advantage of the capital gains rule that offers up to $500,000 tax-free upon the sale of the property. The capital gain rules dictate that if a person is married and have lived on the property for more than two years, they qualify for a $500,000 deduction from the sale of the land.
Whether or Not the Client and His Child Should Take a Salary or Cash Distribution
Filling of the articles of incorporation gives a corporation its mandate to conduct business transactions. A board of directors handles and manages all management responsibilities on behalf of the shareholders who elect the board. The directors, in turn, appoint officers who are accountable for the day to day operations of the establishment. For small organizations like that of Bob Jones, the corporation can have a minimum of one to two shareholders, with the second being the daughter where one can be the sole officer and the other a director. By registering a corporation, the shareholders will separate from the business, which becomes a legal entity (Bankman, Shaviro, Stark, & Kleinbard, 2018). Moreover, there will be no liability on the personal assets of the shareholders in case of the company's debts or obligations. Besides, if one of the shareholders dies, the company will continue to exist and transact business as usual.
The best type of corporation for the father-daughter company is the C Corporation, where the company will pay taxes on the profits generated. The shareholders under this corporation will enjoy increased planning succession, increased capability to reorganize, and recapitalize the enterprise through its growth process, as well as enjoy the ease of accessing investment capital. Thus, the father and daughter should pay themselves cash distributions because they attract no taxes.
References
Bankman, J., Shaviro, D. N., Stark, K. J., & Kleinbard, E. D. (2018). Federal Income Taxation . Illinois: Aspen Publishers.
Blaufus, K., & Hoffmann, F. (2019). The effect of simplified cash accounting on tax and financial accounting compliance costs. Journal of Business Economics , 1-33.
De Boer, D., Gill, D., Destremau, K., & Hensen, M. (2016). Assessing the stock of regulation: A tool for regulatory stewards.
Feld, L. P., Ruf, M., Schreiber, U., Todtenhaupt, M., & Voget, J. (2019). Corporate Capital Gains Taxation and Acquisition Activity. ZEW-Centre for European Economic Research Discussion Paper , (16-007).
Rappaport, M. E. (2016). The Unique Income Tax Issues of Collectibles. Journal of Taxation of Investments , 33 (2).
