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Chapter 03 Tax Planning Strategies and Related Limitations

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Question;True / False Questions;1. The goal;of tax planning is tax minimization.;True False;2. Nontax;factors do not play an important role in tax planning.;True False;3. Virtually;every transaction involves the taxpayer and two other parties that have an;interest in the tax ramifications of the transaction.;True False;4. The;timing strategy is based on the idea that where income is taxed affects the tax;costs of the income.;True False;5. In;general, tax planners prefer to accelerate deductions.;True False;6. The;concept of present value is an important part of the timing strategy.;True False;7. Assuming;an after-tax rate of return of 10%, John should prefer to pay $85 today instead;of $100 in one year.;True False;8. The time;value of money suggests that $1 in one year is worth less than $1 today.;True False;9. The;present value concept becomes more important as interest rates increase.;True False;10. Future;value can be computed as Future Value = Present Value/(1 + r)n.;True False;11. When;considering cash inflows, higher present values are preferred.;True False;12. When;considering cash outflows, higher present values are preferred.;True False;13. Tax;savings generated from deductions are considered cash inflows.;True False;14. In;general, tax planners prefer to defer income. This is an example of the;conversion strategy.;True False;15. The timing;strategy is particularly effective for cash basis taxpayers.;True False;16. The timing;strategy becomes more attractive as tax rates decrease.;True False;17. The timing;strategy becomes more attractive as interest rates (i.e., rates of return);increase.;True False;18. The timing;strategy becomes more attractive if a taxpayer is able to accelerate deductions;by two or more years (versus one year).;True False;19. One;limitation of the timing strategy is the difficulties in accelerating a tax;deduction without accelerating the actual cash outflow that generates the tax;deduction.;True False;20. The;constructive receipt doctrine is a natural limitation for the conversion;strategy.;True False;21. The;constructive receipt doctrine is more of an issue for cash basis taxpayers.;True False;22. If tax;rates will be higher next year, taxpayers should accelerate their deductions regardless;of their after-tax rate of return.;True False;23. If tax;rates will be lower next year, taxpayers should accelerate their deductions;regardless of their after-tax rate of return.;True False;24. If tax;rates will be higher next year, taxpayers should defer their income to next;year regardless of their after-tax rate of return.;True False;25. The value;of a tax deduction is higher for a taxpayer with a lower tax rate.;True False;26. The income;shifting strategy requires taxpayers with varying tax rates.;True False;27. The;assignment of income doctrine is a natural limitation to the timing strategy.;True False;28. The;business purpose, step-transaction, and substance-over-form doctrines may limit;the income shifting strategy.;True False;29. Paying;dividends to shareholders is one effective way of shifting income from a;corporation to its shareholders.;True False;30. The;conversion strategy capitalizes on the fact that tax rates vary across;different activities.;True False;31. Implicit;taxes may reduce the benefits of the conversion strategy.;True False;32. The;business purpose, step transaction, and substance over form doctrines may limit;the conversion strategy.;True False;33. Tax;avoidance is a legal activity that forms the basis of the basic tax planning;strategies discussed in class.;True False;34. Tax;evasion is a legal activity that forms the basis of the basic tax planning;strategies discussed in class.;True False;35. The;rewards of tax avoidance include stiff monetary penalties and imprisonment.;True False;Multiple Choice Questions;36. The goal;of tax planning generally is to;A. Minimize;taxes;B. Minimize;IRS scrutiny;C. Maximize;after-tax wealth;D. Support;the Federal government;E. None of;these;37. Effective;tax planning does not require consideration of;A. nontax;factors;B. the;taxpayer's tax costs of alternative transactions;C. the other;party's tax costs of alternative transactions;D. the other;party's nontax costs of alternative transactions;E. None of;these;38. Which is;not a basic tax planning strategy?;A. income;shifting;B. timing;C. conversion;D. arms;length transaction;E. None of;these;39. Which of;the following strategies is based on the present value of money?;A. timing;B. tax;avoidance;C. income;shifting;D. conversion;E. None of;these;40. Assuming a;positive interest rate, the present value of money suggests;A. $1 today;= $1 in one year;B. $1 today;$1 in one year;C. $1 today;< $1 in one year;D. $1 today;<= $1 in one year;E. None of;these;41. If Joel;earns a 10% after-tax rate of return, $10,000 received in two years is worth;how much today (rounded)?;A. $10,000;B. $9,090;C. $8,260;D. $11,000;E. None of;these;42. If Lucy;earns a 6% after-tax rate of return, $8,000 received in four years is worth how;much today?;A. $8,000;B. $7,544;C. $8,989;D. $6,336;E. None of;these;43. If Nicolai;earns an 8% after-tax rate of return, $20,000 today would be worth how much to;Nicolai in 5 years?;A. $20,000;B. $13,620;C. $18,520;D. $21,600;E. None of;these;44. If Scott;earns a 12% after-tax rate of return, $15,000 today would be worth how much to;Scott in 2 years?;A. $15,000;B. $11,955;C. $18,520;D. $18,816;E. None of;these;45. If Rudy;has a 25% tax rate and a 6% after-tax rate of return, a $30,000 tax deduction;in four years will save how much tax in today's dollars (rounded)?;A. $30,000;B. $7,500;C. $28,290;D. $5,940;E. None of;these;46. If Julius;has a 30% tax rate and a 10% after-tax rate of return, a $40,000 tax deduction;in two years will save how much tax in today's dollars (rounded)?;A. $40,000;B. $9,912;C. $33,040;D. $12,000;E. None of;these;47. If Thomas;has a 40% tax rate and a 6% after-tax rate of return, $50,000 of income in five;years will cost him how much tax in today's dollars (rounded)?;A. $50,000;B. $20,000;C. $37,350;D. $14,940;E. None of;these;48. If Julius;has a 20% tax rate and a 10% after-tax rate of return, $25,000 of income in;three years will cost him how much tax in today's dollars (rounded)?;A. $3,755;B. $18,775;C. $5,000;D. $25,000;E. None of;these;49. Which of;the following increases the benefits of income deferral?;A. increasing;tax rates;B. smaller;after-tax rate of return;C. larger;after-tax rate of return;D. smaller;magnitude of transactions;E. None of;these;50. Which of;the following decreases the benefits of accelerating deductions?;A. decreasing;tax rates;B. smaller;after-tax rate of return;C. larger;after-tax rate of return;D. larger;magnitude of transactions;E. None of;these;51. Which of;the following does not limit the benefits of deferring income?;A. increasing;tax rates;B. a;taxpayer with severe cash flow needs;C. if;continuing an investment would generate a low rate of return;D. if;continuing an investment would subject the taxpayer to unnecessary risk;E. None of;these;52. The;constructive receipt doctrine;A. is;particularly restrictive for accrual basis taxpayers;B. causes;income to be recognized before it is actually received;C. causes;income to be recognized after it is actually received;D. applies;equally to income and expenses;E. None of;these;53. Rolando's;employer pays year-end bonuses each year on December 31. Rolando, a cash basis;taxpayer, would prefer to not pay tax on his bonus this year. So, he leaves;town on December 31, 2014 and doesn't pick up his check until January 2nd;2015. When should Rolando report his bonus?;A. 2015;B. 2014;C. Rolando;can choose the year to report the income;D. It does;not matter;E. None of;these;54. If tax;rates are decreasing;A. taxpayers;should accelerate income;B. taxpayers;should defer deductions;C. taxpayers;should defer income;D. taxpayers;should defer deductions and accelerate income;E. None of;these;55. If tax;rates are decreasing;A. taxpayers;should accelerate income;B. taxpayers;should defer deductions;C. taxpayers;should accelerate deductions;D. taxpayers;should defer deductions and accelerate income;E. None of;these;56. If tax;rates are increasing;A. taxpayers;should accelerate income;B. taxpayers;should defer deductions;C. taxpayers;should defer income;D. you need;more information to make a recommendation;E. None of;these;57. Which of;the following is not required to determine the best timing strategy?;A. the;taxpayer's after-tax rate of return;B. the;taxpayer's tax rate this year;C. the;taxpayer's tax rate in future years;D. the;taxpayer's tax rate last year;E. None of;these;58. Which of;the following is an example of the timing strategy?;A. A;corporation paying its shareholders a $20,000 dividend;B. A parent;employing her child in the family business;C. A;taxpayer gifting stock to his children;D. A;cash-basis business delaying billing its customers until after year end;E. None of;these;59. Which of;the following is an example of the timing strategy?;A. A cash;basis taxpayer paying all outstanding bills by year end;B. A parent;employing her child in the family business;C. A;business paying its owner a $30,000 salary;D. A;taxpayer investing in a tax preferred investment;E. None of;these;60. Which of;the following does not limit the income shifting strategy?;A. assignment;of income doctrine;B. business;purpose doctrine;C. substance-over-form;doctrine;D. step-transaction;doctrine;E. None of;these;61. A taxpayer;paying his 10 year old daughter $50,000 a year for consulting likely violates;which doctrine?;A. constructive;receipt doctrine;B. implicit;tax doctrine;C. substance-over-form;doctrine;D. step-transaction;doctrine;E. None of;these;62. A taxpayer;instructing her son to collect rent checks for the taxpayer's property and to;report this as taxable income on the son's tax return violates which doctrine?;A. constructive;receipt doctrine;B. implicit;tax doctrine;C. assignment;of income doctrine;D. step-transaction;doctrine;E. None of;these;63. Which of;the following is needed to implement the income shifting strategy?;A. taxpayers;with varying tax rates;B. decreasing;tax rates;C. increasing;tax rates;D. unrelated;taxpayers;E. None of;these;64. A common;income shifting strategy is to;A. shift;income from low tax rate taxpayers to high tax rate taxpayers;B. shift;deductions from low tax rate taxpayers to high tax rate taxpayers;C. shift;deductions from high tax rate taxpayers to low tax rate taxpayers;D. accelerate;tax deductions;E. None of;these;65. Jason's;employer pays year-end bonuses each year on December 31. Jason, a cash basis;taxpayer, would prefer to not pay tax on his bonus this year (and actually;would prefer his daughter to pay tax on the bonus). So, he leaves town on;December 31, 2014 and has his daughter, Julie, pick up his check on January;2nd, 2015. Who reports the income and when?;A. Julie in;2014;B. Julie in;2015;C. Jason in;2014;D. Jason in;2015;E. None of;these;66. Which of;the following is more likely to receive IRS scrutiny under the assignment of;income doctrine?;A. A;corporation paying its shareholders a $20,000 dividend;B. A parent;employing her child in the family business;C. A;taxpayer gifting stock to his children;D. A;cash-basis business delaying billing its customers until after year end;E. None of;these;67. Which of;the following is an example of the income shifting strategy?;A. A;corporation paying its shareholders a $20,000 dividend;B. A;corporation paying its owner a $20,000 salary;C. A high;tax rate taxpayer investing in tax exempt municipal bonds;D. A;cash-basis business delaying billing its customers until after year end;E. None of;these;68. Which of;the following is an example of the conversion strategy?;A. A;corporation paying its shareholders a $20,000 dividend;B. A;corporation paying its owner a $20,000 salary;C. A high;tax rate taxpayer investing in tax exempt municipal bonds;D. A;cash-basis business delaying billing its customers until after year end;E. None of;these;69. Which of;the following may limit the conversion strategy?;A. implicit;taxes;B. assignment;of income doctrine;C. constructive;receipt doctrine;D. activities;with preferential tax rates;E. None of;these;70. Assume;that Bill's marginal tax rate is 30%. If corporate bonds pay 8% interest, what;interest rate would a municipal bond have to offer for Bill to be indifferent;between the two bonds?;A. 30%;B. 10.4%;C. 8%;D. 7%;E. None of;these;71. Assume;that John's marginal tax rate is 40%. If a city of Austin bond pays 6%;interest, what interest rate would a corporate bond have to offer for John to be;indifferent between the two bonds?;A. 30%;B. 10%;C. 6%;D. 3.6%;E. None of;these;72. Assume;that Larry's marginal tax rate is 25%. If corporate bonds pay 10% interest;what interest rate would a municipal bond have to offer for Larry to be;indifferent between the two bonds?;A. 25%;B. 12.5%;C. 10%;D. 7.5%;E. None of;these;73. Assume;that Lavonia's marginal tax rate is 20%. If a city of Tampa bond pays 5%;interest, what interest rate would a corporate bond have to offer for Lavonia;to be indifferent between the two bonds?;A. 20%;B. 8%;C. 7%;D. 4%;E. None of;these;74. Assume;that Marsha is indifferent between investing in a city of Destin bond that pays;6% interest and a corporate bond that pays 8% interest. What is Marsha's;marginal tax rate?;A. 50%;B. 40%;C. 30%;D. 20%;E. None of these;75. Assume;that Javier is indifferent between investing in a city of El Paso bond that;pays 5% interest and a corporate bond that pays 6.25% interest. What is;Javier's marginal tax rate?;A. 50%;B. 40%;C. 30%;D. 20%;E. None of;these;76. Assume;that Lucas' marginal tax rate is 30% and his tax rate on dividends is 15%. If a;dividend-paying stock (with no growth potential) pays an 8% dividend yield;what interest rate would a municipal bond have to offer for Lucas to be;indifferent between the two investments?;A. 30%;B. 15%;C. 8%;D. 6.8%;E. None of;these;77. Assume;that Keisha's marginal tax rate is 40% and her tax rate on dividends is 15%. If;a city of Atlanta bond pays 7.65% interest, what dividend yield would a dividend-paying;stock (with no growth potential) have to offer for Keisha to be indifferent;between the two investments?;A. 15%;B. 10%;C. 9%;D. 7.65%;E. None of;these;78. Assume;that Shavonne's marginal tax rate is 50% and her tax rate on dividends is 15%.;If a corporate bond pays 10.2% interest, what dividend yield would a;dividend-paying stock (with no growth potential) have to offer for Shavonne to;be indifferent between the two investments?;A. 6%;B. 7%;C. 10.2%;D. 15%;E. None of;these;79. Assume;that Will's marginal tax rate is 32% and his tax rate on dividends is 15%. If a;dividend-paying stock (with no growth potential) pays a dividend yield of 8%, what;interest rate must the corporate bond offer for Will to be indifferent between;the two investments?;A. 12%;B. 11%;C. 10%;D. 8%;E. None of;these;80. Assume;that Jose is indifferent between investing in a corporate bond that pays 10%;interest and a stock with no growth potential that pays an 8% dividend yield.;Assume that the tax rate on dividends is 15%. What is Jose's marginal tax rate?;A. 47%;B. 37%;C. 32%;D. 15%;E. None of;these;81. Assume;that Juanita is indifferent between investing in a corporate bond that pays;10.2% interest and a stock with no growth potential that pays a 6% dividend;yield. Assume that the tax rate on dividends is 15%. What is Juanita's marginal;tax rate?;A. 50%;B. 40%;C. 30%;D. 15%;E. None of;these;82. The income;shifting and timing strategies are examples of;A. tax;avoidance;B. tax;evasion;C. illegal;taxpayer strategies;D. All of;these;E. None of;these;83. A taxpayer;earning income in "cash" and not reporting it as taxable income is an;example of;A. tax;avoidance;B. tax;evasion;C. conversion;D. income;shifting;E. None of;these;84. Investing;in municipal bonds to avoid paying tax on interest earned and to earn a higher;after-tax yield is an example of;A. conversion;B. tax;evasion;C. timing;D. income;shifting;E. None of;these;85. Paying;fabricated" expenses in high tax rate years is an example of;A. conversion;B. tax;evasion;C. timing;D. income;shifting;E. None of;these;Essay Questions;86. Danny;argues that tax accountants suffer from one-mindedness in their attempts at tax;planning (i.e., reducing taxes at all costs). Is Danny's view of tax planning;correct - i.e., does he understand what the goal of tax planning is? Please;elaborate.;87. An astute;tax student once summarized that many of the tax planning strategies merely;make use of the variation of taxation across different dimensions. Explain why;this is true. Be specific.;88. There are;two basic timing-related tax rate strategies. What are they? What is the intent;of each strategy? In which situations do the tax rate and timing strategies;provide conflicting recommendations? What information do you need to determine;the appropriate action?;89. Based only;on the information provided for each scenario, determine whether Eddy or Scott;will benefit more from using the timing strategy and why there will be a;benefit to that person.;a. Eddy has a 40% tax rate. Scott has a 30% tax rate.;b. Eddy and Scott each have a 40% tax rate. Eddy has $10,000;of income that could be deferred, Scott has $20,000 of income that could be;shifted.;c. Eddy and Scott each have a 40% tax rate and $20,000 of;income that could be deferred. Eddy's after-tax rate of return is 8%. Scott's;after-tax rate of return is 10%.;d. Eddy and Scott each have a 40% tax rate, $20,000 of;income that could be deferred, and an after-tax rate of return of 10%. Eddy can;defer income up to 3 years. Scott can defer income up to 2 years.;90. Based only;on the information provided for each scenario, determine whether Kristi or;Cindy will benefit more from using the timing strategy and why there will be a;benefit to that person.;a. Kristi has a 40% tax rate and can defer $20,000 of;income. Cindy has a 30% tax rate and can defer $30,000 of income.;b. Kristy has a 30% tax rate, a 10% after-tax rate of;return, and can defer $25,000 of income for three years. Cindy has a 40% tax;rate, an 8% after-tax rate of return, and can defer $20,000 of income for four;years.;91. David, an;attorney and cash basis taxpayer, is new to the concept of tax planning and;recently learned of the timing strategy. To implement the timing strategy;David plans to establish a new policy that allows his clients to wait up to;five years to pay their attorney fees. Assume that David expects his marginal;tax rates to remain constant over the foreseeable future. What is wrong with;this strategy?;92. Explain;why $1 today is not equal to $1 in the future. Why is understanding this concept;particularly important for tax planning? What tax strategy exploits this;concept?;93. Luther was;very excited to hear about the potential tax savings from shifting income from;his corporation to him. The next day he had his corporation declare a $30,000;dividend to him. Is this an effective income shifting strategy? If so, why? If;not, why not? What recommendations do you have for Luther?;94. Compare;and contrast the constructive receipt doctrine and the assignment of income;doctrine.;In what situations do these doctrines apply? What tax;planning strategies does each doctrine limit?;95. Lucinda is;contemplating a long range planning strategy that will allow her to defer;sizable portions of her income for 10 years. What type of planning strategy is;she contemplating? What are some potential risks associated with this type of;strategy?;96. Jared, a;tax novice, has recently learned of several foreign tax havens (i.e., countries;with low tax rates). He is considering locating his manufacturing operations in;one of these countries solely based on their low tax rates. What types of taxes;is Jared ignoring? Explain how these other taxes may affect the viability of;Jared's choice to locate in a foreign tax haven.;97. Richard;recently received $10,000 of compensation for some consulting work (paid in;cash). Jeffrey recently received $10,000 of interest income from City of Dallas;bonds. Both taxpayers report no taxable income from these transactions. Is this;considered tax avoidance or tax evasion? What is the difference, if any;between the two?;98. Antonella;works for a company that pays a year-end bonus in December of each year. Assume;that Antonella expects to receive a $20,000 bonus in December this year, her;tax rate is 30%, and her after-tax rate of return is 8%. If Antonella's;employer paid her bonus on January 1 of next year instead of December, how much;would this action save Antonella in today's tax dollars? If Antonella's tax;rate increased to 32% next year, would receiving the bonus in January still be;advantageous?;99. Joe Harry;a cash basis taxpayer, owes $20,000 in tax deductible accounting fees for his;business. Assume that it is December 28 and that Joe Harry can avoid any;finance charges if he pays the accounting fees by January 10th. Joe Harry's tax;rate this year is 30%. His tax rate next year will be 33%. His after-tax rate;of return is 8%. When should Joe Harry pay the $20,000 fees and why?;100. Rodney, a;cash basis taxpayer, owes $40,000 in tax deductible consulting fees for his;business. Assume that it is December 28 and that Rodney can avoid any finance;charges if he pays the accounting fees by January 10th. Rodney's tax rate this;year is 30% and his after-tax rate of return is 10%. At what tax rate next;year, will Rodney be indifferent between paying the $40,000 this year and next;year?;101. Troy is not;a very astute investor. He has a knack for investing in losing stocks. In his;latest investment move, he has realized a loss of about $40,000 (original basis;of $50,000, current fair market value of $10,000) in High Tech, Inc. The good;news is that unlike prior years, he actually has $45,000 of gains that he can;use to offset the loss. Troy is considering either selling the High Tech, Inc.;stock to his sister, Louise, or on the stock market. Which should he choose and;why? Please explain why the IRS may treat the two transactions differently.;102. O'Reilly is;a masterful lottery player. The megamillion jackpot is now up to $200 million.;If O'Reilly wins the jackpot, he has a choice of receiving $200 million in 5;years or a smaller lump sum currently. Advise O'Reilly on his choice under the;following scenarios. Which option should he take and why?;a. O'Reilly's after tax return is 10%. If he chooses the;current lump sum option, the lottery will pay him $130 million.;b. O'Reilly's after-tax return is 10%. His current tax rate;will be 35% if he receives the lottery payment now. His expected tax rate in;five years will be 40%. If he chooses the current lump sum option, the lottery;will pay him $100 million.;103. Sal, a;calendar year taxpayer, uses the cash-basis method of accounting for his sole;proprietorship. In late December he performed $40,000 of consulting services;for a client. Sal typically requires his clients to pay his bills immediately;upon receipt. Assume that Sal's marginal tax rate is 30% this year and 35% next;year and that he can earn an after-tax rate of return of 12% on his;investments. Should Sal send his client the bill in December or January?;104. Lucky owns;a maid service that cleans several local businesses nightly. Lucky, a high-tax;rate taxpayer, would like to shift some income to his son Rocco. Lucky tells;all of his customers (who are always timely in their payments) to pay Rocco and;then Rocco will report 50% of the income as a collection fee. Lucky will report;the remaining 50%. Will this shift the income from Lucky to Rocco? Why or why;not? What doctrines influence your answer? Any suggestions for Lucky?;105. Bono owns;and operates a sole proprietorship and has a 30% marginal tax rate. He provides;his son, Richie, $12,000 a year for college expenses. Richie, works as a street;musician and has a marginal tax rate of 15%. What could Bono do to reduce his;family tax burden? How much pre-tax income does it currently take Bono to;generate the $12,000 after-taxes given to Richie? If Richie worked for his;father's sole proprietorship, what salary would Bono have to pay him to;generate $12,000 after taxes? (Ignore any Social Security, Medicare, or Self;Employment Tax issues.) How much money would this strategy save?;106. Jayzee is a;single taxpayer who operates a sole proprietorship. He expects his taxable;income next year to be $150,000, of which $125,000 is attributed to his sole;proprietorship. Jayzee is contemplating incorporating his sole proprietorship.;Using the 2014 single individual tax brackets and the corporate tax brackets;how much current tax could this strategy save Jayzee? (Ignore any Social;Security, Medicare, or Self Employment Tax issues.) How much income should be;retained in the corporation?;107. Bobby and;Whitney are husband and wife and Whitney operates a sole proprietorship. They;expect their joint taxable income next year to be $200,000, of which $125,000;is attributed to the sole proprietorship. Whitney is contemplating;incorporating the sole proprietorship. Using the 2014 married filing joint tax;brackets and the corporate tax brackets, how much current tax could this;strategy save Bobby and Whitney? How much income should be retained in the;corporation?;108. Rob is;currently considering investing in municipal bonds that earn 4% interest or;taxable bonds issued by Dell Computer that pay 6.5%. If Rob's tax rate is 20%;which bond should he choose? Which bond should he choose if his tax rate is;30%? At what tax rate would he be indifferent to the municipal bond or to the;corporate bond? What strategy is this decision based upon?;109. Maurice is;currently considering investing in a high dividend yield stock with no growth;potential that pays a 6% dividend yield or bonds issued by The Coca Cola;Company that pay 8%. If Maurice's ordinary tax rate is 25% and his dividend tax;rate is 15%, which investment should he choose? Which investment should he;choose if his ordinary tax rate is 30%? At what ordinary tax rate would he be;indifferent to the stock or to the bond? What strategy is this decision based;upon?;110. Boeing is;considering opening a plant in two neighboring states. One state has a;corporate tax rate of 15%. If operated in this state, the plant is expected to;generate $1,200,000 pre-tax profit. The other state has a corporate tax rate of;5%. If operated in this state, the plant is expected to generate $1,085,000 of;pre-tax profit. Which state should Boeing choose? Why do you think the plant in;the state with a lower tax rate would produce a lower pre-tax income?

 

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