Tax Effect of Salary Dividends & Cash Withdrawal

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Bob wants to withdraw money from his 401(k) and use it to finance his new business. According to the Pension and Annuity Income in Publication 575, his 401(k) payments may have been pre-taxed (IRS, 2020). Being elderly, he will not be penalized for withdrawing from his account early on, which should cost him 10% of his savings. Therefore, the whole $690,000 is considered ordinary income and is maximally tax-bracketed at 37% as of 2019 rates. As a result, this transaction takes $221,000, which means Bob remains with $480,000 to invest in his venture.

Bob also considers selling his asset and using the proceeds to finance his new venture. Thus, he is concerned about its effect on capital-output and gross income tax. According to Publication 544, he has several options to help minimize his property’s sale tax, maximizing his payout, especially since he has held the property for years. According to Rupert and Kenneth (2019), when one holds property for more than a year, a tax rate of long-term capital gains (LTCG) is applied. Rupert and Kenneth (2019) further reveal that this rate is 0% on income less than $39,375, 15% for earnings ranging from $39,376 to $434,550, and is 20% for revenues exceeding $434,551. Since he has terminated his 401(k), his year’s revenue is $506,000, which is the sum of interest and dividends, he should tax the 20% LTCG rate. It is also important to note that any costs associated with selling the asset reduced his gain, affecting the tax he owes. By assuming a real estate commission of 6%, Bob’s payout after all the deductions becomes $6,408,000, as shown in the table below.

Table 1: Bob’s Payout Calculation

Particulars	Amount
Sale	$9,000,000
Cost (deduct)	-450,000
Capital profit from long-term asset	8,550,000
Sale of Real Estate (charged 6% of the sale)	-540,000
Net Profit	8,010,000
Tax bracket (used on net profit)	20%
Tax	1,602,000

Payout (net profit- tax)	6,408,000

Such factors as appraisals, surveys, and closing costs are likely to reduce payout after taxation due to the minimization of tax costs. The capital transactions report is provided in Schedule D, one of the several schedules attached to the Individual Income Tax Return Form 1040 for all U.S. citizens (IRS, 2020). The document mentioned above lists capital assets, such as bonds, stocks, and buildings. Form 8949 reports profit and loss from capita and investments, respectively. Schedule D may ask the client to produce other forms, which have information regarding property sales, theft, or any other casualty resulting in losses (IRS, 2020). More specifically, part I and II of Schedule D are used to disclose financial information such as short-term and long-term profits and losses, respectively, while part III summarizes the two accounts.

Bob can appreciate how to handle sales revenue, exchange, or asset disposal provided in IRS Publication 544, which delineates how to calculate profits and losses. According to IRS (2021), the publication can help him apply the values and how to divulge them to the Internal Revenue Service (IRS). As indicated above, Bob is to be charged 20% for selling his property, which is the maximum rate per the LTCG. Consequently, this raises his cash flow by $6,408,000 when he finalizes selling his property. Moreover, Bob’s cash flow will increase since he does not pay any more mortgage interest or taxes levied on his real estate property.

If Bob chooses to structure his venture as a corporation, it is recommended for him to receive salaries up to the IRS’s highest level. According to Rupert and Kenneth (2019), such a business structure allows for salary deductions and tax bill reductions when it is newly structured. Ownership of the company depends on the shares held by a partner of the business. Moreover, this is a distinct entity subjected to double taxation, one on its profits and the other on the shareholders’ dividends. Contrary to tax-payers in the non-corporate sector, who can deduct close to $3,000 when they incurred losses resulting from ordinary income, a corporation offsets its losses from gains (Rupert & Kenneth, 2019). The latter can carry back such losses to three tax years and forward its profits for five years, all of which are considered short-term losses.

If Bob gives preference to partnership business structure, he will avoid double taxation seen in corporations. According to Rupert and Kenneth (2019), all the revenues earned and the losses incurred are shared among the organization’s partners. Since he is willing to give his daughter a 40% share of the business, he will get $180,000 one year later. Doing this would put him in a tax bracket at 32%. Thus, if deductions from exclusions, credits, or AGI are not factored in, then Bob’s tax bill becomes 38,916.50 dollars for the specific financial year.

Structuring the business as an S-Corporation means Bob needs to pass the various business finances such as deductions, losses, revenues, and credits through its stockholders for the federal taxation process. The organization must operate in the U.S., be eligible, and have a maximum of 100 shareholders (Rupert & Kenneth, 2019). His old car can be used to check all these marks. All the income items such as profits and losses for ST or LT, gains and losses for section 1231, charities, credits, and others are considered separately on the return since each item affects various stakeholders’ tax returns (Rupert & Kenneth, 2019). Therefore, the organization is similar to the C-corporation, where shareholders’ incomes are used to offset the losses incurred by the business. However, it is an unfavorable situation for S-corporation since it does not qualify for other corporate deductions such as dividends given to the stockholders. The reason is that any property it distributes is considered a return on capital if the business does not have accumulated revenues and profits. Therefore, an S-corporation is Bob’s best choice because it is not subjected to double taxation.