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Exam 3: Tax Planning Strategies and Related Limitations

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Question 31

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Implicit taxes may reduce the benefits of the conversion strategy.

A) True
B) False

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Question 32

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Assuming an after-tax rate of return of 10 percent, John should prefer to pay an expense of $85 today instead of an expense of $100 in one year. Use Exhibit 3.1.

A) True
B) False

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Question 33

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The timing strategy becomes more attractive as interest rates (i.e., rates of return)increase.

If Julius has a 22 percent tax rate and a 9 percent after-tax rate of return, $44,500 of income in three years will cost him how much tax in today's dollars? Use Exhibit 3.1. (Round discount factor(s) to three decimal places.)

The timing strategy becomes more attractive as tax rates decrease.

The timing strategy becomes more attractive if a taxpayer is able to accelerate deductions by two or more years (versus one year).

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

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

Luther was very excited to hear about the potential tax savings from shifting income from his corporation to himself. 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?

Which of the following decreases the benefits of accelerating deductions?

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?

Assume that Marsha is indifferent between investing in a city of Destin bond that pays 6 percent interest and a corporate bond that pays 8 percent interest. What is Marsha's marginal tax rate?

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.

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 2020 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)

Bono owns and operates a sole proprietorship and has a 32 percent 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 percent. What could Bono do to reduce his family tax burden? How much pretax 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?

Assume that Bill's marginal tax rate is 42 percent. If corporate bonds pay 6 percent interest, what interest rate would a municipal bond have to offer for Bill to be indifferent between the two bonds? (Do not round your final answer.)

If Thomas has a 37 percent tax rate and a 6 percent 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 discount factor(s) to three decimal places.)

Compare and contrast the constructive receipt doctrine and the assignment of income doctrine. In what situations do these doctrines apply? What tax planning strategies does each doctrine limit?

Boeing is considering opening a plant in one of two neighboring states. One state has a corporate tax rate of 15 percent. If operated in this state, the plant is expected to generate $1,200,000 pretax profit. The other state has a corporate tax rate of 5 percent. If operated in this state, the plant is expected to generate $1,085,000 of pretax profit. Which state should Boeing choose based upon tax considerations only? Why do you think the plant in the state with a lower tax rate would produce a lower pretax income?

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