Question 1

Bono owns and operates a sole proprietorship and has a 30% marginal tax rate. He provides his son, Richie, $12,000 a year for college expenses. Richie, works as a street musician and has a marginal tax rate of 15%. What could Bono do to reduce his family tax burden? How much pre-tax income does it currently take Bono to generate the $12,000 after-taxes given to Richie? If Richie worked for his father's sole proprietorship, what salary would Bono have to pay him to generate $12,000 after taxes? (Ignore any Social Security, Medicare, or Self Employment Tax issues.) How much money would this strategy save?

Accepted Answer

Bono could reduce his family's tax burde...

Question 2

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?

Accepted Answer

Assuming an investor can earn a positive...

Question 3

Bobby and Whitney are husband and wife and Whitney operates a sole proprietorship. They expect their joint taxable income next year to be $200,000, of which $125,000 is attributed to the sole proprietorship. Whitney is contemplating incorporating the sole proprietorship. Using the 2014 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?

Accepted Answer

Assuming Bobby and Whitney's goal is to ...

Question 4

The present value concept becomes more important as interest rates increase.

Accepted Answer

A) True 
 B)False

Question 5

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

Accepted Answer

A)   A corporation paying its shareholders a $20,000 dividend
B)   A corporation paying its owner a $20,000 salary
C)   A high tax rate taxpayer investing in tax exempt municipal bonds
D)   A cash-basis business delaying billing its customers until after year end
E)   None of theseF) C) and D)
G) All of the above

Question 6

The concept of present value is an important part of the timing strategy.

Accepted Answer

A) True 
 B)False

Question 7

The constructive receipt doctrine is more of an issue for cash basis taxpayers.

Accepted Answer

A) True 
 B)False

Question 8

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

Accepted Answer

A) True 
 B)False

Question 9

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 2014 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?

Accepted Answer

Assuming Jayzee's goal is to minimize his current federal income tax exposure, one can compare the single individual and corporate tax rate schedules to achieve this goal. Since Jayzee has $25,000 of taxable income not related to his sole proprietorship, he is currently in the 15% tax bracket. The task is to allocate the $125,000 between Jayzee and his corporation to minimize his current liability. The lowest corporate tax rate is 15% (taxable income from 0 to $50,000) and is equivalent to Jayzee's marginal tax rate of 15%. To take advantage of the remaining $11,900 of the 15% individual tax bracket ($36,900 - $25,000) and the 15% corporate tax bracket, $11,900 of the profits should be shifted to Jayzee and $50,000 of the expected $125,000 in profits should be retained in the corporation. [$50,000 is the width of the 15% corporate tax bracket.] Jayzee's personal marginal tax rate would now be 25% and his corporation's marginal tax rate would also be 25%. Let's assume that, all things equal, Jayzee prefers to receive the profits personally. To take advantage of Jayzee's 25% personal tax bracket, the next $52,450 of the expected $125,000 in profits should be shifted to Jayzee. [$52,450 is the width of Jayzee's 25% tax bracket]. Jayzee's marginal tax rate would now be 28% and $114,350 of the corporation's profits have been allocated . Continuing this same decision process, the remaining $10,650 of corporate profits should be retained in the corporation and taxed at 25%. In sum, $60,650 of the expected profits are retained in the corporation and $64,350 of the profits are shifted to Jayzee.
This strategy will save Jayzee $6,819.50 calculated as: (a) The tax on $\$ 150,000$ of taxable income reported 
$\quad\quad$by Jayzee assuming that he operates his business 
$\quad\quad$as a sole proprietorship $\quad\quad\quad\quad\quad\quad$$$\$ 35,175.75$$
Less:
(b) The tax on $\$ 89,350$ of taxable income reported 
$\quad\quad$by Jayzee assuming that he incorporates his business $\quad\quad\quad\quad\quad - \$ 18,193.75 \\ $ and (c) the tax on $\$ 60,650$ profits retained in the corporation $\quad\quad\quad\quad - \$ 10,162.50$
$$= \$ 6,819.50$$

Question 10

Assume that John's marginal tax rate is 40%. If a city of Austin bond pays 6% interest, what interest rate would a corporate bond have to offer for John to be indifferent between the two bonds?

Accepted Answer

A)   30%
B)   10%
C)   6%
D)   3.6%
E)   None of theseF) B) and E)
G) A) and B)

Question 11

One limitation of the timing strategy is the difficulties in accelerating a tax deduction without accelerating the actual cash outflow that generates the tax deduction.

Accepted Answer

A) True 
 B)False

Question 12

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

Accepted Answer

A) True 
 B)False

Question 13

Troy is not a very astute investor. He has a knack for investing in losing stocks. In his latest investment move, he has realized a loss of about $40,000 (original basis of $50,000; current fair market value of $10,000) in High Tech, Inc. The good news is that unlike prior years, he actually has $45,000 of gains that he can use to offset the loss. Troy is considering either selling the High Tech, Inc. stock to his sister, Louise, or on the stock market. Which should he choose and why? Please explain why the IRS may treat the two transactions differently.

Accepted Answer

If Troy sells the stock to his sister, b...

Question 14

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, 2014 and has his daughter, Julie, pick up his check on January 2nd, 2015. Who reports the income and when?

Accepted Answer

A)   Julie in 2014
B)   Julie in 2015
C)   Jason in 2014
D)   Jason in 2015
E)   None of theseF) A) and E)
G) B) and E)

Question 15

Assume that Jose is indifferent between investing in a corporate bond that pays 10% interest and a stock with no growth potential that pays an 8% dividend yield. Assume that the tax rate on dividends is 15%. What is Jose's marginal tax rate?

Accepted Answer

A)   47%
B)   37%
C)   32%
D)   15%
E)   None of theseF) All of the above
G) A) and D)

Question 16

Assume that Lucas' marginal tax rate is 30% and his tax rate on dividends is 15%. If a dividend-paying stock (with no growth potential)  pays an 8% dividend yield, what interest rate would a municipal bond have to offer for Lucas to be indifferent between the two investments?

Accepted Answer

A)   30%
B)   15%
C)   8%
D)   6.8%
E)   None of theseF) A) and B)
G) C) and D)

Question 17

If tax rates will be higher next year, taxpayers should defer their income to next year regardless of their after-tax rate of return.

Accepted Answer

A) True 
 B)False

Question 18

Richard recently received $10,000 of compensation for some consulting work (paid in cash). Jeffrey recently received $10,000 of interest income from City of Dallas bonds. Both taxpayers report no taxable income from these transactions. Is this considered tax avoidance or tax evasion? What is the difference, if any, between the two?

Accepted Answer

Richard is engaged in tax evasion. Jeffrey is engaged in tax avoidance. Tax avoidance is the legal act of arranging one's affairs to minimize taxation. The rewards of tax avoidance include maximizing the taxpayer's wealth. It has long been endorsed by the courts and Congress. In contrast to tax avoidance, tax evasion (willful intent to defraud the government) falls outside the confines of legal tax avoidance. The "rewards" of tax evasion include civil and criminal penalties, including large monetary fines and sentencing to federal prison. In many cases there is a clear distinction between avoidance (e.g., not paying tax on municipal bond interest) and evasion (e.g., not paying tax on $10,000 of compensation). In other cases, the line between tax avoidance and evasion is less clear. In these situations, professional judgment, the use of a "smell test," and consideration of the business purpose, step transaction, and substance-over-form doctrines may prove useful.

Question 19

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

Accepted Answer

A)   conversion
B)   tax evasion
C)   timing
D)   income shifting
E)   None of theseF) C) and D)
G) A) and E) B

Question 20

Assume that Lavonia's marginal tax rate is 20%. If a city of Tampa bond pays 5% interest, what interest rate would a corporate bond have to offer for Lavonia to be indifferent between the two bonds?

Accepted Answer

A)   20%
B)   8%
C)   7%
D)   4%
E)   None of theseF) None of the above
G) D) and E)

Exam 3: Tax Planning Strategies and Related Limitations

Correct Answer
verified
Bono could reduce his family's tax burde...
View Answer

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?

Correct Answer
verified
Assuming an investor can earn a positive...
View Answer

Correct Answer
verified
Assuming Bobby and Whitney's goal is to ...
View Answer

The present value concept becomes more important as interest rates increase.

Correct Answer
verified

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

Correct Answer
verified

The concept of present value is an important part of the timing strategy.

Correct Answer
verified

The constructive receipt doctrine is more of an issue for cash basis taxpayers.

Correct Answer
verified

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

Correct Answer
verified

Assume that John's marginal tax rate is 40%. If a city of Austin bond pays 6% interest, what interest rate would a corporate bond have to offer for John to be indifferent between the two bonds?

Correct Answer
verified

One limitation of the timing strategy is the difficulties in accelerating a tax deduction without accelerating the actual cash outflow that generates the tax deduction.

Correct Answer
verified

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

Correct Answer
verified

Correct Answer
verified
If Troy sells the stock to his sister, b...
View Answer

Correct Answer
verified

Assume that Jose is indifferent between investing in a corporate bond that pays 10% interest and a stock with no growth potential that pays an 8% dividend yield. Assume that the tax rate on dividends is 15%. What is Jose's marginal tax rate?

Correct Answer
verified

Assume that Lucas' marginal tax rate is 30% and his tax rate on dividends is 15%. If a dividend-paying stock (with no growth potential) pays an 8% dividend yield, what interest rate would a municipal bond have to offer for Lucas to be indifferent between the two investments?

Correct Answer
verified

If tax rates will be higher next year, taxpayers should defer their income to next year regardless of their after-tax rate of return.

Correct Answer
verified

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

Correct Answer
verified
B

Assume that Lavonia's marginal tax rate is 20%. If a city of Tampa bond pays 5% interest, what interest rate would a corporate bond have to offer for Lavonia to be indifferent between the two bonds?

Correct Answer
verified

Exam 3: Tax Planning Strategies and Related Limitations

Correct AnswerverifiedBono could reduce his family's tax burde...View AnswerShow Answer

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?

Correct AnswerverifiedAssuming an investor can earn a positive...View AnswerShow Answer

Correct AnswerverifiedAssuming Bobby and Whitney's goal is to ...View AnswerShow Answer

The present value concept becomes more important as interest rates increase.

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedShow Answer

The concept of present value is an important part of the timing strategy.

Correct AnswerverifiedShow Answer

The constructive receipt doctrine is more of an issue for cash basis taxpayers.

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedShow Answer

Assume that John's marginal tax rate is 40%. If a city of Austin bond pays 6% interest, what interest rate would a corporate bond have to offer for John to be indifferent between the two bonds?

Correct AnswerverifiedShow Answer

One limitation of the timing strategy is the difficulties in accelerating a tax deduction without accelerating the actual cash outflow that generates the tax deduction.

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedShow Answer

Correct AnswerverifiedIf Troy sells the stock to his sister, b...View AnswerShow Answer

Correct AnswerverifiedShow Answer

Assume that Jose is indifferent between investing in a corporate bond that pays 10% interest and a stock with no growth potential that pays an 8% dividend yield. Assume that the tax rate on dividends is 15%. What is Jose's marginal tax rate?

Correct AnswerverifiedShow Answer

Assume that Lucas' marginal tax rate is 30% and his tax rate on dividends is 15%. If a dividend-paying stock (with no growth potential) pays an 8% dividend yield, what interest rate would a municipal bond have to offer for Lucas to be indifferent between the two investments?

Correct AnswerverifiedShow Answer

If tax rates will be higher next year, taxpayers should defer their income to next year regardless of their after-tax rate of return.

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedB

Assume that Lavonia's marginal tax rate is 20%. If a city of Tampa bond pays 5% interest, what interest rate would a corporate bond have to offer for Lavonia to be indifferent between the two bonds?

Correct AnswerverifiedShow Answer

Correct Answer
verified
Bono could reduce his family's tax burde...
View Answer

Correct Answer
verified
Assuming an investor can earn a positive...
View Answer

Correct Answer
verified
Assuming Bobby and Whitney's goal is to ...
View Answer

Correct Answer
verified

Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
verified

Correct Answer
verified
If Troy sells the stock to his sister, b...
View Answer

Correct Answer
verified

Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
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B

Correct Answer
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