Tax Effects of Salaries Withdrawn from a Business

Milestone 2
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Subject and Section
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July 2, 2022
Understanding the various effects of withdrawing cash from the company’s revenues is essential for any business manager. It allows him to make strategic decisions on reducing the organization’s taxable income, thereby increasing profit. In this case, one of the questions asked is the tax effect of providing $180,000 per year to the client’s salary and $70,000 per year for the daughter’s salary. Accordingly, one of the considerations that must be made in this case is the fact that Bob’s business is a sole proprietorship. The case suggests explicitly that Bob has neither partner nor other members who would be considered as incorporates. There was also no indication that the business is an LLC or an incorporation, which means that it must be considered a sole proprietorship. 
            As a sole proprietor, Bob has the only option of paying himself a business salary and not a dividend (Ross, 2021). This is only an option on the part of Bob and not a mandatory requirement compared to the declaration of dividends in certain instances. Accordingly, a business salary (or self-employment) may be imposed at a taxable rate of 15.3%, which they can either pay themselves in full. They also have the option to deduct half the cost, which would then be payable by the business (Fitzpatrick, n.d.). Notably, however, this taxable income is composed of Social Security and Medicare, which comprise 12.4% and 2.9%, respectively. 
           Since the case provides that Bob is hoping to pay $180,000 in business salary for himself every year, this means that his taxable income is $27,450.00. This would be divided into $22,230.00 and $5,220.00, respectively. As stated earlier, however, Bob may pay this self-employment tax rate in full or have one-half of it paid by his car business (Fitzpatrick, n.d.).            
           As regards her daughter, the tax effect would be different. Since the proposal to make his daughter both a manager and owner (with 40% interest) has not yet been given effect, then his daughter is still considered an employee of his business. Following the tax code, this means that there is a high possibility that his daughter’s income of $70,000, given as a form of salary, would be considered a tax deduction. 
           However, while the general rule is that employee’s wages are deductible from the taxable income of sole proprietorships, jurisprudence provides that the following requirements must be met to wit; (1) the compensation must be ordinary and necessary, (2) it is reasonable in amount, (3) it is paid for services actually provided, and (4) it is “actuall...