Ordinary Income and Capital Gains Tax
Question 1a
Ordinary Income
Ordinary income is the earned income an individual gets from employment, business or sale of the property. It is in forms of salaries, commissions, tips, bonuses, risk rewards gained by working in a company. Most importantly, ordinary income is summed up from one’s own business or individual company. In our case, in order for one to make a sale resulting in capital gains, the underlying asset being sold must be a capital asset. Ignoring the capital gains tax, the sale proceeds from the apartments generate ordinary income for Nikki. A capital asset by exclusion is one that5 is not a capital asset and is held by the taxpayer primarily for sale to customers in the ordinary course of trade. In Nikki’s case, the asset is a capital asset. Thus it accumulates capital gain tax, which when paid by the local real estate agent, the profiting sales proceeds forms part of Nikki’s ordinary income.
Under the special government considerations to influence people to invest, the government taxes capital gains and dividend stocks at lower rates than the ordinary income. The inclusion of the real estate agent makes Nikki an investor. Apart from the tax reduction and near exception by the capital gain tax, the resulting streams of income she gets from the sales of individual apartments form her ordinary income. “The favourable tax treatment in investments always results in a huge ordinary tax for investors” (Fleischer, 2015), such as Nikki.
In focusing on the ability of the property to generate ordinary income, factors that focus on the nature and purpose of the property are considered. Nikki had held the land for some time as a clothing store for her business before the land appreciated markedly. This means she intends to maximize the utility of income; this is only achievable by expanding investment. Also, Nikki was earning ordinary income from her clothing store that was situated on the same land. The destruction of the clothing store structure to develop the appreciated land into a selling-apartments form her part of a plan to increase her disposable income. In order to get to disposable income, there must be an increase in ordinary income. Therefore, the earned income from her other six stored, added to the proceeds for the apartments’ sale, considered as part for the seventh store form the basic ordinary income. It is therefore concrete to conclude that the dealer real estate agent manager Nikki’s properties while Nikki’s is the investor who receives capital and profit proceeds. “An increase in one’s income is dependent on the increasing levels of his/her disposable income, holding other factors such as capital gain tax constant” (Boyd, 2011).
Question 1b
CGT Small Business Concessions
Small business CGT concessions are the 50% active asset reduction. One can reduce the capital gain tax on an active asset owned within twelve months or more, in addition to the 50% CGT tax discount, Also, a near-retirement exemption on capital gains tax on sales of active assets up to a lifetime limit of $500,000.
As a small sole trader, Ken can access a range of small business concession, including reporting and payment options. This, Ken could do by determining and confirming if his business entities, as of his partnerships i.e. PI Pty Limited where he has a 42% of the total shares accumulating to $126,000, which is way below the aggregated $2 million mark. In a partner business, Ken could register for a small concession business if the 80% of shares in the investment property is limited to a short and partnership form of a corporation, with a payable fee of $300,000 mortgage over the same. In a similar ownership ratio, the amount payable by Ken in the business is $240,000, which again reduces the capital gain tax.
“The classification of a small business is one that has less than 1500 employees and makes less than $35.5million in global sales depending on the industry” (Qian & Xing, 2016). This suits all Ken’s businesses, including his rental apartments, and former home. Even though the number of Ken’s employees are not mentioned, it is evident that has active years of business are contemplatively reduced, and thus the transfer of ownership to Jane through the premises. Ken, himself concentrates in liquating his assets to cash convertibles, as he assumes the retirement age in a few years and laity in business transactions. Additionally, the modesty of his profits after costs and taxes is not worth the continued investment and business operations.
Ken can qualify for the small business CGT concessions. Ken’s businesses do not have any restructure rollover, as the settlements with Jane are done out of the CGT transactions, independently between the two agreeing parties. Even though Ken’s Hawthorn asset is $3 million, and the annual turnover of the previously owned two premises runs at $3 million in turnover, Ken does not carry any other business, other than the property investment business that he carries with his cousin, with the majority of the shares (80%) being his, and the CGT assets are used in the small business at PT Pty Limited, Kew home has $510, 000 value. In addition to this, Ken hold passive assets under Jane’s control, including the rental premise, Kew apartment before its sale, and the PI Pty Limited assets.
The capital assets under question as a result of an interest in a partnership asset. The PI Pty Limited and the Investment property are both co-owned with different profit distribution formula resulting from transactional interests. It is also clear that the Ken acquired the initial premises under his ownership, not from any partnership interest. The second premises under which Jane operates do not have a partner’s name attached to it. Therefore, it is solely Ken’s and not a product of the partnership’s interest. The capital assets Ken owns also satisfy the maximum capital and asset value tests. “The total value of the properties does not need to exceed $6 million if a business owner wants to qualify for a small business concession” (Szpulak, 2015), not indexed to inflation from the period of 3003-2019. The entities connected to Ken, including himself, affiliations, assets held and used before, and has busies connections to him. Initially, Ken operated the two store premises himself selling furniture products, and do not include the assets of Jane after the sale. Therefore, Ken satisfies the maximum net value asset test.
The assets under consideration owned by Ken satisfies the active asset tests. Ken has utilized his held assets both in sole proprietorship and partnerships. In addition to the leasing of one of the premises to Jane at a fee, Ken’s has an intangible asset of goodwill at Jane’s second premise. An additional intangible asset that Ken owns is the payment of no competition that runs over three years at $200,000. The duration from 2003 to 2019 is more than the required period, which is set at 7½ years and 15 years.
Additionally, Ken’s assets under consideration are a share in a company, and some interest earnings are a trust. The Investment property business that Ken operates with his cousin with the majority of shares being his has active interest earnings in a trust form. Ken’s assets also have membership interest of the entity of the partnership between his two co-owned companies of PT Pty Limited and Investment property.
Net Capital Gain
With a net capital gain, low tax rates apply than in the ordinary income. The net capital gain is the amount by which one’s net long term capital gain over a year than the short term losses of that particular year. This will be calculated from subtracting the basis from the net proceeds. The retail purchase price was $300,00 each in the period Ken purchased them in 2003; the was also an aggregate turnover of $3million on each premise before Ken decided to sell them. “This means that an average rise in the net capital gain exceeds the inflation deficit” (Keane & Iskhakov, 2018) and proceeds from the sale of furniture in both premises. A sale to Jane of a single premise store at $1,200,000 and goodwill of $400,00 means a massive capital gain on that single store. Additional a rental lease for two years with a monthly pay of $2,000, an upfront lease, and a commitment fee not to compete for three years payable to Ken further ballooned the net capital gain.
On the PI Pty Limited and the Investment property assets, a 42% and 80% share ratings meant that at nay dissolution of the companies, a greater capital gain would be on Ken. Also, the Investment property has a higher value than the debt it owed to the creditors, i.e. $300.000 mortgage fees payable by the firm is far less than its vale of $500,000. Moreover, the value that Ken is supposed to settle is only $240,000, far less than the Ken’s $400,000 ownership in the firm. The Kew apartments were also sold at a price over the acquisition cost.
References
Boyd, A. (1951). Taxation: Federal Income Tax: Sale of Un matured Crop as Capital Gain or Ordinary Income. Michigan Law Review, 49(8), 1254. https://doi.org/10.2307/1284639
Fleischer, V. (2015). Two and Twenty Revisited: Taxing Carried Interest as Ordinary Income Through Executive Action Instead of Legislation. SSRN Electronic Journal. https://doi.org/10.2139/ssrn.2661623
Keane, M., & Iskhakov, F. (2018). Effects of Taxes and Safety Net Pensions on Life-Cycle Labor Supply, Savings and Human Capital: The Case of Australia. SSRN Electronic Journal. https://doi.org/10.2139/ssrn.3182093
Qian, W., & Xing, K. (2016). Linking Environmental and Financial Performance for Privately Owned Firms: Some Evidence from Australia. Journal of Small Business Management, 56(2), 330-347. https://doi.org/10.1111/jsbm.12261
Szpulak, A. (2015). Evaluating net investments in the operating working capital under certainty: The integrated approach to working capital management. Business and Economic Horizons, 11(1), 28-40. https://doi.org/10.15208/beh.2015.03