Case study 1: Capital Gains Tax
With respect to real estate, capital gains can be defined as the difference between the price that someone bought a piece of property for, and the price he or she sells it for. On the other hand, capital gains tax is what the property owner pays on that difference once adjustments have been made for various exemptions, breaks and deductions. This tax is calculated independently of someones regular income, and in most cases at a dissimilar rate. Together with federal capital gain taxes, a majority of states in the US also tax the gains.
To calculate the capital gains tax, the cost of any improvements made to the property is added to the propertys purchase price. Then, the sale price of the property is adjusted for sale expenses such as a real estate agents commission, any closing costs the property owner agreed to pay, and legal fees. From this adjusted sale price, the adjusted purchase price is deducted. The property owner is advised to check for any federal and state exemptions that he or she is entitled to. It is also worthy considering how long the individual has owned the property. This is because short-term capital gains, which involve property that was sold less than one year after it was bought, are taxed at a similar rate to regular income. On the other hand, long-term gains are taxed at a lower rate.
In this case study, Fred sold his home for $800,000, incurring legal fees of $1100 and $9900 as a commission for the real estate agent. He had bought the home for $100,000, paying $2,000 in stamp duty and legal fees amounting to $1000, and also constructed a garage worth $20,000. Adding the purchase price to the cost of improvements to the property equals to $120,000. The sale expenses add up to $11,000, which when subtracted from the sale price brings an adjusted sale price of $789,000. $120,000 subtracted from this adjusted sale price presents a net capital gain of $669,000.
It is assumed that Fred had a net capital loss of $10,000 from the previous year that arose from selling shares. The capital gain figure calculated above would have been much different if the loss had resulted from selling an antique vase. When an individual sells something for instance a share of stock, for an amount that is more than that person paid for, he or she is going to get taxed on this increase in value. The increment in value is referred to as capital gain. As mentioned earlier, to calculate the amount of gain, any cost basis in the asset is subtracted from the proceedings gotten from the sale. Often, the cost basis is simply the amount that the individual paid for that asset, and is inclusive of any brokerage commissions that may have been paid on the transaction.
The amount of tax charged on capital gain will depend on whether it was a LTCG (long-term capital gain), or a STCG (short-term capital gain). If the asset that had been sold had been possessed by the owner for a period of less than a year, then it is a STCG. On the other hand, if it was possessed for a time period of over a year, then it is a LTCG. Taxation on STCGs is done on a basis of normal income rates, while LTCGs are taxed at rates similar to those of qualified dividend income. This means that any long-term capital gains falling in the highest tax bracket (39.6%) will be taxed at a rate of a mere 20%. Also, any LTCG falling in the tax bracket of between 25% and 35% will be taxed at a rate of 15%, while that falling in the bracket of between 10% and 15% does not get taxed at all. A crucial point to note here is that if an individual ever considers selling an investment whose value has increased, it is advisable to consider holding the asset for long enough so that its capital gain can be considered long-term. It is also worth noting that the only instance that capital gain occurs is when an asset is sold. This is of great importance as it means that fluctuations in the assets value should not be considered as tax events.
Mutual funds tend to be collections of a very huge quantity of other kinds of investments. For example, a mutual fund may contain thousands of different stocks together with any number of other investments such as option contracts or bonds. Every year, a mutual fund, as is the case with any other investor, is subject to income tax on any net capital gains it may have incurred within that year. All in all, rather than the mutual fund paying those taxes by itself, every one of its shareholder pays taxes on their share of the related gains. Each year, the portion of gains allocated to every shareholder gets reported to his or her Form 1099-DIC that is then sent by the fund firm. It is worth noting that even in years in which the value reduces, there is a possibility that responsibility for paying taxes on a gain falls on the investors. The opposite is also correct. In certain years, the fund increases in value although sales of investments within the funds portfolio lead to a net capital loss. Therefore, investors get an increase in their holdings value, but they are not supposed to pay any taxes at the moment.
Sometimes, things do not always go as planned. In case an individual sells an asset for less than the amount he or she paid for, something called a capital loss is incurred. As is the case with capital gains, capital losses are categorized either as long-term or short-term, based on whether the asset was possessed by the owner for more than or less than a year. Every year, an investor should add up all of his or her short-term capital losses, and then subtract them from his or her short-term capital gains. Afterwards, the person should add together all of his or her long-term capital losses and subtract them from his or her long-term capital gains. Should be the end result be a positive STCG and LTCG, the long-term capital gain will get taxed at a maximum 20% rate while the short-term capital gain gets taxed at normal income tax rates.
Case Study 2: Fringe Benefits Tax
Fringe benefits are a crucial part of any business, and are an ideal way of attracting competent staff members. However, if a business is going to offer fringe benefits for its staff, like the way Periwinkle Pty Ltd did, its managers need to be aware of its taxation obligations. Fringe Benefits Tax, abbreviated as FBT, is a tax employers are supposed to pay for benefits paid to either an employee, or his or her association such as a family member in place of wages or salaries. This kind of tax is not part of income tax, and is usually calculated based on the taxable value of any benefits offered.
Everybody loves free benefits. Employees consider them valuable freebies. In the case of employers, they would not be offering them if they were getting nothing valuable in return. For a company to secure the best and most efficient workers, it has to entice them with benefits that have nothing to do with income. An employee can get fringe benefits such as a car, car packing, payment of private expenses, or low-interest loans. It is a completely legal and commonly used form of reimbursement by organizations for their employees. All in all, some popular benefits can in some cases add wrinkles to an employees taxes. If an individual gets educational benefits from an employer by enrolling in an educational assistance program, he or she can exclude not more than $5,250 of the benefits from his or her reported annual income. For any extra benefits exceeding this amount, the employee has to pay income tax. If any benefits that exceed $5,250 also meet the requirements to be perceived as a working condition fringe benefit, the employer is not compelled to include them in the employees wages. A working condition fringe benefit is one which, had the worker paid for it, he or she could deduct it terming it an as an employee business-oriented expense.
For a plan to pass through as an educational assistance program, it must be in a written form, and satisfy certain other requirements. Some educational benefits are usually not taxed, such as tuition, books, fees, equipment and supplies. However, these benefits do not include accommodation, transportation or meals, or any supplies or tools that the student can keep once the course is completed. Neither does it include courses that involve games, hobbies nor sports, unless they are part of a diploma program, or are linked to the business conducted by the company. The program courses covered for the plan include any training or instruction that develops or improves the employees capabilities. Payments made do not necessarily have to be courses making up a degree program, or work-related courses.
If an employee is provided with a vehicle, like the case of Emma the Periwinkle employee, the amount considered as a working condition fringe benefits and which can be excluded is one that is allowable as a deductible expense if she paid for its use. If the car is used for both some business and personal use, the benefits value is the part involving business use. In some cases, the amount of working condition benefit does not have to be excluded. Rather, the entire yearly lease value of the car is included in the employees wages. He or she can afterwards stake claim on any business expense that is deductible for the car in the form of an documented deduction on his or her taxes.
Businesses are often not notified of the amount of fringe benefits tax they have to pay. They are expected to self-assess their own FBT liability every FBT year than runs between 1st of April and 31st of March. The FBT rate usually varies with each year, with the current rate being 49%. There are a number of steps that Periwinkle Company should have taken when calculating Emmas FBT. The first step was to determine the type of fringe benefits that it offers its employees. Then, the taxable value of every fringe benefit the business offers to every employee is worked out. Once this is done, the company will calculate the total taxable value of all the benefits offered, which it can claim as GST credit. The value of the benefits in which GST cannot be claimed is also determined. There are a number of rules applied in calculating a fringe benefits taxable value, and usually depend on the type of benefit.
Damodaran, A. (2012). Investment valuation: Tools and techniques for determining the value of any asset (Vol. 666). John Wiley & Sons.
Hodgson, H., & Pearce, P. (2015). TravelSmart or travel tax free breaks: Is the fringe benefits tax a barrier to active commuting in Australia?.
Schneider, K. N. (2013). Soften the blow by providing tax-free fringe benefits to terminated employees. Journal of Legal Issues and Cases in Business, 2, 0_1.
Yinger, J., Bloom, H. S., & Boersch-Supan, A. (2016). Property taxes and house values: The theory and estimation of intrajurisdictional property tax capitalization. Elsevier.
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