Exam 3: Tax Planning Strategies and Related Limitations

Joe Harry, a cash-basis taxpayer, owes $25,000 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 5 percent. When should Joe Harry pay the $25,000 fees and why? Use Exhibit 3.1. (Round discount factor(s)to three decimal places.)

The timing strategy becomes more attractive as tax rates decrease.

Bono owns and operates a sole proprietorship and has a 32 percent marginal tax rate. He provides his son, Richie, $6,000 a year for college expenses. Richie works as a street musician and has a marginal tax rate of 15 percent. What could Bono do to reduce his family tax burden? How much pretax income does it currently take Bono to generate the $6,000 after taxes given to Richie? If Richie worked for his father's sole proprietorship, what salary would Bono have to pay him to generate $6,000 after taxes? (Ignore any Social Security, Medicare, or self-employment tax issues.)How much money would this strategy save?

If tax rates will be lower next year, taxpayers should accelerate their deductions regardless of their after-tax rate of return.

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?

If Joel earns a 10 percent after-tax rate of return, $10,000 received in two years is worth how much today? Use Exhibit 3.1. (Round discount factor(s)to three decimal places.)

The business purpose, step-transaction, and substance-over-form doctrines may limit the income-shifting strategy.

Which of the following is an example of the timing strategy?

The timing strategy becomes more attractive as interest rates (i.e., rates of return)increase.

Assume that Lavonia's marginal tax rate is 22 percent. If a city of Tampa bond pays 5 percent interest, what interest rate would a corporate bond have to offer for Lavonia to be indifferent between the two bonds?

Sal, a calendar-year taxpayer, uses the cash-basis method of accounting for his sole proprietorship. In late December, he performed $34,000 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 6 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.)

Maurice is currently considering investing in a high dividend yield stock with no growth potential that pays a 6 percent dividend yield or bonds issued by the Coca-Cola Company that pay 8 percent. If Maurice's ordinary tax rate is 25 percent and his dividend tax rate is 15 percent, which investment should he choose? Which investment should he choose if his ordinary tax rate is 30 percent? At what ordinary tax rate would he be indifferent between the stock and the bond? What strategy is this decision based upon?

A common income-shifting strategy is to:

Assume that Javier is indifferent between investing in a city of El Paso bond that pays 3.05 percent interest and a corporate bond that pays 4.4 percent interest. What is Javier's marginal tax rate?

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, 2019, and doesn't pick up his check until January 2, 2020. When should Rolando report his bonus?

Assume that Jose is indifferent between investing in a corporate bond that pays 10 percent interest and a stock with no growth potential that pays an 8.6 percent dividend yield. Assume that the tax rate on dividends is 15 percent. What is Jose's marginal tax rate? (Do not round intermediate computations.)

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?

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.)

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?

The business purpose, step-transaction, and substance-over-form doctrines may limit the conversion strategy.