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 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?

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?

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, 2016 and doesn't pick up his check until January 2, 2017. When should Rolando report his bonus?

If Scott earns a 12% after-tax rate of return, $15,000 today would be worth how much to Scott in 2 years? (round present and future value amounts to 3 places)

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

The assignment of income doctrine is a natural limitation to the timing strategy.

Which of the following decreases the benefits of accelerating deductions?

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, 2016 and has his daughter, Julie, pick up his check on January 2, 2017. Who reports the income and when?

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 from a cash-flow perspective?

The value of a tax deduction is higher for a taxpayer with a lower tax rate.

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 $150,000 is attributed to the sole proprietorship. Whitney is contemplating incorporating the sole proprietorship. Using the 2016 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?

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 from a cash-flow perspective?

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?

The timing strategy becomes more attractive as tax rates decrease.

The conversion strategy capitalizes on the fact that tax rates vary across different activities.

Implicit taxes may reduce the benefits of the conversion strategy.

A common income shifting strategy is to:

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

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?

If Joel earns a 10% after-tax rate of return, $10,000 received in two years is worth how much today? (round present and future value amounts to 3 places)