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Exam 3: Tax Planning Strategies and Related Limitations

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Question 41

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

A) True
B) False

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Question 42

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The income shifting and timing strategies are examples of:

A) tax avoidance
B) tax evasion
C) illegal taxpayer strategies
D) All of these
E) None of these

F) C) and D)
G) B) and E)

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Question 43

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

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

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?

The timing strategy becomes more attractive as tax rates decrease.

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.

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

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

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

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?

Assume that Javier is indifferent between investing in a city of El Paso bond that pays 5% interest and a corporate bond that pays 6.25% interest. What is Javier's marginal tax rate?

Rodney, a cash basis taxpayer, owes $40,000 in tax deductible consulting fees for his business. Assume that it is December 28 and that Rodney can avoid any finance charges if he pays the accounting fees by January 10th. 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?

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

There are two basic timing-related tax rate strategies. What are they? What is the intent of each strategy? In which situations do the tax rate and timing strategies provide conflicting recommendations? What information do you need to determine the appropriate action?

Joe Harry, a cash basis taxpayer, owes $20,000 in tax deductible accounting fees for his business. Assume that it is December 28 and that Joe Harry can avoid any finance charges if he pays the accounting fees by January 10th. 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?

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 (rounded) ?

An astute tax student once summarized that many of the tax planning strategies merely make use of the variation of taxation across different dimensions. Explain why this is true. Be specific.

Which of the following is not required to determine the best timing strategy?

Nontax factors do not play an important role in tax planning.