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Exam 3: Tax Planning Strategies and Related Limitations

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Question 1

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If Julius has a 22 percent tax rate and a 10 percent after-tax rate of return, $25,000 of income in three years will cost him how much tax in today's dollars? Use Exhibit 3.1. (Rounddiscount factor(s) to three decimal places.)

A) $4,131
B) $18,775
C) $5,500
D) $25,000
E) None of the choices are correct.

F) C) and E)
G) A) and B)

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Question 2

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If Tom invests $70,000 in a taxable corporate bond that provides a 5 percent before-tax return, how much will Tom's investment be worth in either 8 or 20 years from now when the bond matures? Assume Tom's marginal tax rate is 35 percent.

A) $103,422; $185,731
B) $105,697; $197,373
C) $92,536; $140,675
D) $90,410; $132,709
E) None of the choices are correct.

F) A) and B)
G) All of the above

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Question 3

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The timing strategy is based on the idea that the location of where the income is taxed affects the tax costs of the income.

Based only on the information provided for each scenario, determine whether Eddy or Scott will benefit more from using the timing strategy and why there will be a benefit to that person. Use Exhibit3.1. a. Eddy has a 40 percent tax rate. Scott has a 30 percent tax rate. b. Eddy and Scott each have a 40 percent tax rate. Eddy has $10,000 of income that could be deferred; Scott has $20,000 of income that could be shifted. c. Eddy and Scott each have a 40 percent tax rate and $20,000 of income that could be deferred. Eddy's after-tax rate of return is 8 percent. Scott's after-tax rate of return is 10 percent. d. Eddy and Scott each have a 40 percent tax rate, $20,000 of income that could be deferred, and an after-tax rate of return of 10 percent. Eddy can defer income up to three years. Scott can defer income up to two years.

Assume that John's marginal tax rate is 37 percent. If a city of Austin bond pays 6 percent interest, what interest rate would a corporate bond have to offer for John to be indifferent between the two bonds?

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?

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?

Which of the following is more likely to receive IRS scrutiny under the assignment of income doctrine?

Lucky owns a maid service that cleans several local businesses nightly. Lucky, a high tax rate taxpayer, would like to shift some income to his son Rocco. Lucky tells all of his customers (who are always timely in their payments)to pay Rocco, and then Rocco will report 50 percent of the income as a collection fee. Lucky will report the remaining 50 percent. Will this shift the income from Lucky to Rocco? Why or why not? What doctrines influence your answer? Any suggestions for Lucky?

Assume that Lucas's marginal tax rate is 32 percent and his tax rate on dividends is 15 percent. If a dividend-paying stock (with no growth potential) pays an 8 percent dividend yield, what interest rate would a municipal bond have to offer for Lucas to be indifferent between the two investments from a cash-flow perspective?

Assume that Keisha's marginal tax rate is 37 percent and her tax rate on dividends is 20 percent. If a city of Atlanta bond pays 6.56 percent 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?

Assuming a positive interest rate, the present value of money suggests:

Tax savings generated from deductions are considered cash inflows.

The time value of money suggests that $1 one year from now is worth less than $1 today.

If Thomas has a 37 percent tax rate and a 12 percent after-tax rate of return, $74,000 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.)

The constructive receipt doctrine is a natural limitation for the conversion strategy.

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 three decimal places.)a. Kristi has a 40 percent tax rate and can defer $32,000 of income. Cindy has a 30 percent tax rate and can defer $42,000 of income. b. Kristy has a 30 percent tax rate and a 9 percent after-tax rate of return and can defer $37,000 of income for three years. Cindy has a 40 percent tax rate and an 7 percent after-tax rate of return and can defer $32,000 of income for four years.

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

Implicit taxes may reduce the benefits of the conversion strategy.

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