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Exam 3: Tax Planning Strategies and Related Limitations

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Question 41

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

A) A cash basis taxpayer paying all outstanding bills by year end.
B) A parent employing her child in the family business.
C) A business paying its owner a $30,000 salary.
D) A taxpayer investing in a tax preferred investment.
E) None of these.

F) A) and D)
G) A) and C)

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Question 42

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

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 these.

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

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Question 43

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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.

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?

Effective tax planning requires all of these considerations except:

Which of the following may limit the conversion strategy?

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

Tax savings generated from deductions are considered cash inflows.

Danny argues that tax accountants suffer from one-mindedness in their attempts at tax planning (i.e., reducing taxes at all costs). Is Danny's view of tax planning correct - i.e., does he understand what the goal of tax planning is? Please elaborate.

Which of the following is an example of the income shifting strategy?

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.

Assume that Juanita is indifferent between investing in a corporate bond that pays 10.2% interest and a stock with no growth potential that pays a 6% dividend yield. Assume that the tax rate on dividends is 15%. What is Juanita's marginal tax rate?

O'Reilly is a masterful lottery player. The megamillion jackpot is now up to $200 million. If O'Reilly wins the jackpot, he has a choice of receiving $200 million in 5 years or a smaller lump sum currently. Advise O'Reilly on his choice under the following scenarios. Which option should he take and why? a. O'Reilly's after-tax return is 10%. If he chooses the current lump sum option, the lottery will pay him $130 million. b. O'Reilly's after-tax return is 10%. His current tax rate will be 35% if he receives the lottery payment now. His expected tax rate in five years will be 40%. If he chooses the current lump sum option, the lottery will pay him $100 million.

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?

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

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?

Virtually every transaction involves the taxpayer and two other parties that have an interest in the tax ramifications of the transaction.

An investment's time horizon does not affect after-tax rates of return on investments taxed annually.

If Nicolai earns an 8% after-tax rate of return, $20,000 today would be worth how much to Nicolai in 5 years? (round present and future value amounts to 3 places)

Tax avoidance is a legal activity that forms the basis of the basic tax planning strategies.