Exam 3: Tax Planning Strategies and Related Limitations

IN THE TEXT -Rodney,a cash basis taxpayer,owes $40,000 in tax deductible consulting fees for his business.Assume that it is December 28ᵗʰ 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? Use Exhibit 3.1.(Round discount factor(s)to 3 decimal places.)

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Question 1

Correct Answer:

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If Rodney pays the $40,000 in December,the $40,000 tax deduction will save him $12,000 (i.e.,$40,000 × 0.30 = $12,000). If Rodney pays the $40,000 in January,the tax savings in today's dollars is computed as:Tax Savings = $40,000 × tax rate × 0.909 (Discount Factor,1 year,10%). For Rodney to be indifferent between paying the $40,000 in December and January,paying the $40,000 in January must generate $12,000 in tax savings.One can use this information to solve for next year's tax rate. Tax Savings = $40,000 × tax rate × 0.909 (Discount Factor,1 year,10%)= $12,000 Tax rate = ($12,000/$40,000)× (1/0.909)= 33.0033% Alternatively,$40,000 × 0.909 = $36,360.$36,360 × tax rate = $12,000.$12,000/$36,360 = 33.0033%

Which of the following is needed to implement the income shifting strategy?

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Question 2

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

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(True/False)

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Question 3

Correct Answer:

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False

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

(True/False)

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Question 4

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?

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Question 5

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.

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Question 6

Joe Harry,a cash basis taxpayer,owes $20,000 in tax deductible accounting fees for his business.Assume that it is December 28ᵗʰ 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? Use Exhibit 3.1.(Round discount factor(s)to 3 decimal places.)

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Question 7

The downside of tax avoidance includes the potential of stiff monetary penalties and imprisonment.

(True/False)

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Question 8

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 2018 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) Note: New Corporate income tax rate has been mentioned as "21% on all taxable income" as per the recent change.

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Question 9

Susan Brown has decided that she would like to go back to school after her kids leave home in five years.To save for her education,Susan would like to invest $25,000 in an investment that provides a high return.If her marginal tax rate is 35 percent,what is Susan's after-tax rate of return for the following investment options? Qualified dividends are taxed at 15 percent. (1)Corporate bond issued at face value with 10 percent stated interest rate payable annually. (2)Dividend-paying stock with an annual qualifying dividend equal to 10% of her investment. (3)Growth stock with an annual growth rate of 8 percent and no dividends paid.(Round your interim calculations to the nearest whole number)

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Question 10

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?

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Question 11

Nontax factors do not play an important role in tax planning.

(True/False)

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Question 12

Investing in municipal bonds to avoid paying tax on interest earned and to earn a higher after-tax yield is an example of:

(Multiple Choice)

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Question 13

Paying "fabricated" expenses in high tax rate years is an example of:

(Multiple Choice)

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Question 14

If tax rates are increasing:

(Multiple Choice)

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Question 15

The timing strategy becomes more attractive as tax rates decrease.

(True/False)

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Question 16

When considering cash inflows,higher present values are preferred.

(True/False)

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Question 17

Assume that Shavonne's marginal tax rate is 50% and her tax rate on dividends is 15%.If a corporate bond pays 10.20% 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?

(Multiple Choice)

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Question 18

If Scott earns a 12% after-tax rate of return,$15,000 today would be worth how much to Scott in 2 years? Future value of $1.(Round present and future value factor(s)to 5 decimal places.)

(Multiple Choice)

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Question 19

Bobby and Whitney are husband and wife and Whitney operates a sole proprietorship.They expect their joint taxable income next year to be $225,000,of which $175,000 is attributed to the sole proprietorship.Whitney is contemplating incorporating the sole proprietorship.Using the 2018 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? (Use tax rate schedule) Note: New Corporate income tax rate has been mentioned as "21% on all taxable income" as per the recent change.

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Question 20

Showing 1 - 20 of 115

Which of the following is needed to implement the income shifting strategy?

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

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

The downside of tax avoidance includes the potential of stiff monetary penalties and imprisonment.

Nontax factors do not play an important role in tax planning.

Investing in municipal bonds to avoid paying tax on interest earned and to earn a higher after-tax yield is an example of:

Paying "fabricated" expenses in high tax rate years is an example of:

If tax rates are increasing:

The timing strategy becomes more attractive as tax rates decrease.

When considering cash inflows,higher present values are preferred.

If Scott earns a 12% after-tax rate of return,$15,000 today would be worth how much to Scott in 2 years? Future value of $1.(Round present and future value factor(s)to 5 decimal places.)

An Introduction to Tax

Tax Compliance, the Irs, and Tax Authorities

Individual Income Tax Overview dependents and Filing Status

Gross Income and Exclusions

Individual for Agi Deductions

Individual Income Tax Computation and Tax Credits

Business Income, deductions, and Accounting Methods

Property Acquisition and Cost Recovery

Property Dispositions

Entities Overview

Corporate Formations and Operations

Corporate Nonliquidating and Liquidating Distributions

Forming and Operating Partnerships

Dispositions of Partnership Interests and Partnership Distributions

S Corporations

Individual From Agi Deductions

Filters