Exam 3: Tax Planning Strategies and Related Limitations

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?

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? Use Exhibit 3.1. 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.

Which of the following increases the benefits of income deferral?

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. Use Exhibit 3.1. (Round discount factor(s) to 3 decimal places.) 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.

When considering cash inflows, higher present values are preferred.

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?

Paying dividends to shareholders is one effective way of shifting income from a corporation to its shareholders.

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? Use Exhibit 3.1. (Round present and future value amounts to 3 places)

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 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.)

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?

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 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.)

Which of the following does not limit the income shifting strategy?

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?

An investment's time horizon does not affect after-tax rates of return on investments taxed annually.

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?

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?

A taxpayer earning income in "cash" and not reporting it as taxable income is an example of:

Effective tax planning requires all of these considerations except:

In general, tax planners prefer to accelerate deductions.

The timing strategy is particularly effective for cash basis taxpayers.