Question

Ms. Singh, who is in the 37 percent tax bracket, owns a residential apartment building that generates $80,000 annual taxable income. She plans to create a family partnership by giving each of her two children a 20 percent equity interest in the building. (She will retain a 60 percent interest.) Ms. Singh will manage the building, and value of her services is $15,000 per year.

Required: If Ms. Singh’s children are in the 12 percent tax bracket, compute the tax savings from this income-shifting arrangement. (Ignore any payroll tax consequences.)

Answer 1

Ms. Singh's creation of a family partnership to give each of her two children a 20% equity interest in her property, while she retains 60%, results in tax savings of $8,000. This is due to her children's lower tax bracket of 12% compared to her 37% bracket.

Step-by-step explanation:

To calculate the tax savings from the income-shifting arrangement for Ms. Singh, first, we need to consider the taxable income generated by the residential apartment building and the tax brackets of the parties involved. The building generates $80,000 annual taxable income.

The total tax savings can be calculated as follows:

• Ms. Singh retains a 60% interest, which equals $80,000 x 0.60 = $48,000. Her initial tax liability on this without the partnership would have been $48,000 x 37% = $17,760.
• Each child receives a 20% interest, which is $80,000 x 0.20 = $16,000 per child. At the children's tax bracket of 12%, the tax paid by each child on their share of the income would be $16,000 x 12% = $1,920.
• So, the total tax paid after forming the partnership becomes $17,760 (Ms. Singh's share) + $1,920 (first child's share) + $1,920 (second child's share) = $21,600.
• Without the partnership, Ms. Singh would have paid 37% tax on the entire $80,000, which would be $80,000 x 37% = $29,600.
• The tax savings due to the income-shifting is therefore $29,600 - $21,600 = $8,000.

Through this arrangement, Ms. Singh was able to shift income to her children who are in a lower tax bracket, significantly reducing the total amount of taxes paid on the income generated by the property.

Answer 2

The tax savings result from Ms. Singh shifting part of her apartment building's income to her children who are in a lower tax bracket. By transferring 20% equity to each child and retaining 60%, Ms. Singh saves $8,000 in taxes, benefiting from the lower marginal tax rates of her children.

Step-by-step explanation:

To compute the tax savings from Ms. Singh's income-shifting arrangement, we need to consider the difference in tax rates between her and her children, as well as the redistribution of the apartment building's income according to the new equity interests. The apartment building generates $80,000 in taxable income annually. Without income shifting, Ms. Singh would pay 37% of $80,000 in taxes, which amounts to $29,600. With the proposed income shifting, Ms. Singh will retain a 60% interest, and each child will hold a 20% interest.

Now, let's calculate the tax due after income shifting:

• Ms. Singh's share of income: 60% of $80,000 = $48,000
• Each child's share of income: 20% of $80,000 = $16,000

Taxes paid by Ms. Singh at 37%: 37% of $48,000 = $17,760
Taxes paid by each child at 12%: 12% of $16,000 = $1,920

Total taxes paid by children combined: $1,920 x 2 = $3,840

Total taxes after income shifting: Ms. Singh's taxes + children's taxes = $17,760 + $3,840 = $21,600

Tax savings from income shifting: Original taxes - Total taxes after income shifting = $29,600 - $21,600 = $8,000

Hence, by redistributing a portion of the income to her children, Ms. Singh can save $8,000 in taxes, as her children are taxed at a lower marginal rate.