Exam 3: Tax Planning Strategies and Related Limitations

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 32 percent this year and 37 percent next year and that he can earn an after-tax rate of return of 12 percent on his investments.Should Sal send his client the bill in December or January? Use Exhibit 3.1.(Round discount factor(s)to three decimal places.)

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.

Luther was very excited to hear about the potential tax savings from shifting income from his corporation to himself.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?

In general,tax planners prefer to defer income.This is an example of the conversion strategy.

The time value of money suggests that $1 one year from now is worth less than $1 today.

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.Use Exhibit 3.1. a.Eddy has a 40 percent tax rate.Scott has a 30 percent tax rate. b.Eddy and Scott each have a 40 percent 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 percent tax rate and $20,000 of income that could be deferred.Eddy's after-tax rate of return is 8 percent.Scott's after-tax rate of return is 10 percent. d.Eddy and Scott each have a 40 percent tax rate,$20,000 of income that could be deferred,and an after-tax rate of return of 10 percent.Eddy can defer income up to three years.Scott can defer income up to two years.

If Nicolai earns an 8 percent after-tax rate of return,$20,000 today would be worth how much to Nicolai in five years? Use future value of $1.(Round discount factor(s)to four decimal places.)

If tax rates are decreasing:

Assume that Juanita is indifferent between investing in a corporate bond that pays 10.20 percent interest and a stock with no growth potential that pays a 6 percent dividend yield.Assume that the tax rate on dividends is 15 percent.What is Juanita's marginal tax rate?

Joe Harry,a cash-basis taxpayer,owes $20,000 in tax-deductible accounting fees for his business.Assume that it is December 28^th and that Joe Harry can avoid any finance charges if he pays the accounting fees by January 10^th.Joe Harry's tax rate this year is 24 percent.His tax rate next year will be 32 percent.His after-tax rate of return is 8 percent.When should Joe Harry pay the $20,000 fees and why? Use Exhibit 3.1.(Round discount factor(s)to three decimal places.)

Rolando's employer pays year-end bonuses each year on December 31.Rolando,a cash-basis taxpayer,would prefer not to pay tax on his bonus this year.So,he leaves town on December 31,2018,and doesn't pick up his check until January 2,2019.When should Rolando report his bonus?

Rodney,a cash-basis taxpayer,owes $40,000 in tax-deductible consulting fees for his business.Assume that it is December 28^th and that Rodney can avoid any finance charges if he pays the accounting fees by January 10^th.Rodney's tax rate this year is 32 percent and his after-tax rate of return is 10 percent.What tax rate next year will make Rodney indifferent between paying the $40,000 this year or next year? Use Exhibit 3.1.(Round discount factor(s)to three decimal places.)

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 2019 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? (Use tax rate schedule)

The timing strategy is based on the idea that the location of where the income is taxed affects the tax costs of the income.

Assume that Shavonne's marginal tax rate is 37 percent and her tax rate on dividends is 15 percent.If a corporate bond pays 10.20 percent 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 from a cash-flow perspective?

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.

Tax avoidance is a legal activity that forms the basis of the basic tax planning strategies.

Effective tax planning requires all of these considerations except:

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?

Assume that John's marginal tax rate is 37 percent.If a city of Austin bond pays 6 percent interest,what interest rate would a corporate bond have to offer for John to be indifferent between the two bonds?