C Cash or Accrual Systems Overall the cash method of accounting is simple and

C cash or accrual systems overall the cash method of

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C. Cash or Accrual Systems Overall. the cash method of accounting is simple and an easy way recognize revenue in a given year. It also, provides a business a snapshot of their cash flow. However, due to the restrictions imposed by the Internal Revenue Code, certain entities are not allowed to use the cash method (i.e. Partnerships, LLC, & Corporations). If a partnership, LLC or corporation has an average sale of less than five million dollars in the last 3 years they are permitted to use the cash method. Accrual method is a more difficult way to recognize revenue, however, through budgeting and proper strategy it can be very beneficial for corporations and partnerships. D. Tax Effects on Cash Flow After paying taxes on the sale of his land, Bob will have a considerable amount of capital to start his used car business. Since he will be starting off with a lot of money,
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` his marginal tax rate will be high. To offset his taxable liability for the year, Bob would have to start up his business and anything he spends towards his business that is necessary and ordinary for his business would be able to be deducted. Also, under section 195, Bob would be able to immediately deduct up to $10,000 of his start- up cost for the taxable year he starts his business. He can also, gift a portion of the sales to his daughter which would also lower his AGI for the next year (26 I.R.C § 170). E. Salary or Cash Distribution Determining to take salary or cash distributions would depend on the business structure Bob selects for his business. If Bob selects to be a single member limited liability company (LLC) income passes through to him. A single member LLC provides Bob the autonomy of a sole proprietorship while protecting his personal assets. He would file taxes on his personal return (1040) and withdraw cash from profits to pay himself as well as an owners draw to give money to his daughter. Both transactions can be reported in schedule C on his personal return. Which is an above the line deduction. A cash distribution is best under a single member LLC all owner draws are pass through as taxable income to Bob. An LLC classified as an S- corporation is also an option for Bob’s business. The benefits are like a partnership and corporation put together. Just like an LLC, an S corporation’s income passes through to the individuals, shareholders (limited at 100) or entities. Income is reported on form 2553 instead of 1040. Salary distributions
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` would be best under this entity because salary expenses are a deductible business expense IRC § 162. Since we have recommended that Bob form an LLC classified as a partnership, distributions that are made are called guaranteed payment (which are salary like distributions) and are based on a member’s interest in the company. Salary or cash distributions do not matter for this entity because either way they are reported the same on schedule K-1 and reported on schedule E on the 1040 form.
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