Deck 12: Tax Planning: Concepts and Strategies

Question 1

The authors conveniently group the tax reduction techniques into five Ds. What are the five Ds?

Answer 1

The five Ds of tax planning techniques are presented below:

Question 2

What is a limited liability company?

Answer 2

A LLC is a form of unincorporated business organization that offers investors limited liability for debts incurred by the business. An LLC is best viewed as a partnership surrounded by a limited liability shield. Properly structured, an LLC is treated as a partnership for federal income tax purposes. It allows organizers to marry the benefits of taxation of a partnership with the limited liability profits of a corporation.

Question 3

How can home ownership be used as a tax deduction strategy?

Answer 3

Perhaps, the most widely used tax planning strategy of diversion is home ownership. Both mortgage interest and interest on home equity loans are deductible and can be used to reduce the tax liability. Even mortgage interest on a vacation home that is also used for rental income is deductible as rental expense as long as the home is used for personal use less than 14 days or 10 percent of the number of days it is rented out, whichever is greater. Real estate taxes are also deductible.
The most significant benefit to home ownership as a tax avoidance strategy is the ability to postpone almost indefinitely the recognition of gains on the sale of the principal residence. Thus, in a principal residence, capital can be accumulated without tax impact. When the time comes for the taxpayer to finally sell out and not reinvest in a primary residence, tax on profits up to $250,000, if single, or $500,000, if married, may be completely avoided. This delaying feature has the positive effect of sheltering up to $250,000, if single, or $500,000, if married, of capital gains from taxation every two years.

Question 4

How are tax shelters treated under the new tax law?

Question 5

What is meant by income deferral?

Question 6

It is asserted that matching income and losses is an effective means of reducing the tax liability. Do you agree with this statement?

Question 7

What considerations apply to the timing of itemized deductions?

Question 8

Describe an effective means of using charitable donations as a method of reducing tax liability.

Question 9

How is investment interest treated in tax planning?

Question 10

Explain "like-kind" exchanges as a tool for reducing tax liability.

Question 11

What is meant by kiddie tax? How can a person use this concept to his/her advantage?

Question 12

What are the rules regarding the deductibility of interest?

Question 13

Explain "other deductions" as a means of reducing tax liability.

Question 14

Explain tax considerations of different types of business organizations.

Question 15

Explain "deferral with pre-tax dollars" as a tax planning strategy.

Question 16

How do you use the "prepayment strategy" as a means of reducing tax liability?

Question 17

Explain "deferral with after-tax dollars" as a tax planning strategy.

Question 18

Describe itemized deductions as a tax planning strategy.

Question 19

Explain income shifting as a strategy for reducing tax liability.

Question 20

Explain "forgotten deductions" as a tax reduction technique.

Question 21

Bob Blumingdale has a dependent son, age 18, who is a computer whiz. He is earning over $25,000 a year writing software programs for Hewlett Packard, even though he is a freshman in college. Bob has just learned about kiddie tax and wants to engage you for tax planning. How do you advise him?

Question 22

Question 2. What are the five Ds of tax planning?

A) Deductibles, deflection, deferral, diminution, diversion
B) Depreciation, deduction, diminution, diversification, deferral
C) Deflection, diversification, deductibles, diminution, diversion
D) Deflection, distribution, diversification, deferral, diversion
E) Diversion, deflection, diminution, deduction, deferral

Question 23

Question 1. If an investor chose to implement a tax strategy which would allow him or her to completely avoid taxation, he or she would be a proponent of which strategy?

A) Deferral
B) Deflection
C) Diversion
D) A and C
E) None of the above. No tax strategy can be used to completely avoid taxation.

Question 24

Question 3. Which of the following are not true with respect to flexible spending accounts?

A) Contributions are made with after-tax dollars
B) Contributions are made with before-tax dollars
C) Contributions may be made by the employee
D) Contributions may be made by the employer
E) Contributions may be made by both the employee and the employer

Question 25

Ron Horworth, age 53, has found an excellent buyer for his home. By selling this home he will realize a capital gain of $150,000. However, if he waits until he is 55, he believes that $125,000 of this gain will be tax free. He doesn't want to lose this opportunity for selling his home now and hence seeks your assistance.

Question 26

Question 12. A viable tax planning strategy for individuals with taxable Social Security is to:

A) Reject Social Security income altogether
B) Reduce modified income to $32,000 for married couples
C) Report only $32,000 as income regardless of the actual amount of income earned
D) Separate Social Security income from Medicare income

Question 27

Question 10. A master limited partnership differs from a limited partnership in that the master limited partnership:

A) Trades directly through units) on major exchanges or on over-the-counter, whereas a limited partnership does not
B) Allows an investor to buy it with a minimum investment, whereas a limited partnership does not
C) Is typically more profitable
D) A and B
E) B and C

Question 28

Myron Stanner has learned from a tax seminar that tax planning is beyond the comprehension of the average person. He is asking for your opinion.

Question 29

Question 15. What are two important income tax-saving strategies?

A) Buying option and internal revenue bonds
B) Income deferral and income acceleration
C) Investing in treasury notes and treasury bonds
D) Buying homes and taxable investments
E) All of the above

Question 30

Jay Smith, a retired engineer, is a risk-averse person. He was quite satisfied with his portfolio which consisted mostly of tax-free municipal bonds. However, his financial planner told him that, although tax-free, municipal bond interest is taken into account in calculating social security taxes. Jay believes that his financial planner is trying to sell him something and is seeking a clarification from you.

Question 31

Question 13. Under the current law 2015), there is "kiddie tax" for children. Which of the following statements isare) true with respect to this controversial tax?

A) It only applies to children under the age of 15
B) It only applies to children who have net investment income greater than $2,100
C) It is only levied on a child's earned income
D) It could subject the child to pay taxes at the parent's highest marginal tax rate
E) B and D

Question 32

Question 8. Which of the following requirements an individual must meet in order to deduct the expenses associated with a secondary residence?

A) Rental income must not be received
B) It is used for personal use the greater of 14 days personally per year or 10 percent of the number of days it is rented out
C) Rental income must be received
D) A and B
E) B and C

Question 33

Mary Shultz has discovered an error in her previous year's tax return. Revising her tax return would result in a hefty refund of $8,000, but Mary is afraid that such an action on her part would trigger a tax audit which might be disastrous. What is your advice?

Question 34

Question 14. When "income timing" is used as a tax strategy:

A) One would want to channel income into a lower tax year
B) It is especially beneficial for the self-employed, since it can be easily adopted by them
C) It is accomplished by prepaying or postponing the payment of certain bills
D) It may be more difficult for the employed taxpayer
E) All of the above are true

Question 35

Question 5. Which of the following couples would benefit the most by postponing marriage until the following year?

A) Couples who have similar amounts of income
B) Couples where one spouse earns substantially more than the other
C) Couples where one spouse earns substantially less than the other
D) B and C
E) A and C

Question 36

Question 4. For 2016, investment interest deduction is limited to:

A) The interest taken out for investment purposes only
B) The taxpayer's earned income
C) The taxpayer's passive income
D) The amount of tax payment for the year
E) The gain only on the investment that was made with the fund borrowed specifically for that investment

Question 37

Question 6. Which of the following expenses are not fully deductible?

A) Property taxes
B) Miscellaneous business expenses
C) Home mortgage interest with certain statutory limits)
D) Charitable contributions with certain statutory limits)
E) State and local taxes

Question 38

Question 7. Which of the following expense deductions are limited by law?

A) Moving expenses
B) Casualty losses
C) Mortgage interest
D) Investment management fees
E) All of the above are limited by law

Question 39

Question 11. Which of the following is not true with respect to a charitable remainder trust?

A) It permits the donor to receive tax benefits
B) It permits the donor to receive income benefits
C) It is revocable
D) It pays the donor income for a certain period or for life and ultimately passes the principal to the charity
E) All of the above are true

Question 40

Question 9. An investor who is contemplating the purchase of tax-free municipal bonds should consider:

A) The impact on taxable Social Security income
B) The alternative minimum tax
C) The impact on pension income
D) A and B
E) All of the above

Question 41

Question 19. A limited liability company I. Has limited access to the privileges enjoyed by a partnership
II) Is a form of unincorporated business organization
III) Can be formed under IRC 1040 and only with the prior approval of the IRS
IV) Is a partnership surrounded by a limited liability shield
V) Combines the benefits of taxation of a corporation with the limited liability of a partnership

A) All are correct answers
B) None are true answers
C) Only II and IV are correct
D) Only II, III, and IV are correct
E) Only IV is correct

Question 42

Question 17. When one has accumulated shares of a stock or a mutual fund over time at different prices, for minimizing taxes, which of the following shares should be sold?

A) Those that cost the most
B) Those that cost the least to provide a larger capital gain
C) It does not matter since the company will automatically compute a weighted average of your various purchase prices
D) It does not matter since the company will automatically sell the shares which cost the least
E) None of the above

Question 43

Question 18. Which is the simplest form of business ownership?

A) Sole proprietorship
B) S corporation
C) C corporation
D) Limited partnership
E) Master limited partnership

Question 44

Question 20. Which of the following areas are not closely scrutinized by the IRS with respect to audits?

A) Interest expenses
B) Mortgage payments
C) Alternative minimum tax
D) Self-employment income
E) All of the above are scrutinized

Question 45

Question 16. Debt incurred to acquire, construct, or substantially improve a principal or secondary residence to the extent that such indebtedness does not exceed $1 million is called an):

A) Outstanding indebtedness
B) Acquisition indebtedness
C) Construction loan
D) Municipal bond
E) Construction indebtedness