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Exam 3: Tax Planning Strategies and Related Limitations

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Question 21

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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?

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Richard is engaged in tax evasion.Jeffre...

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Question 22

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

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Question 23

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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?

If Lucy earns a 6 percent after-tax rate of return, $8,000 received in four years is worth how much today? Use Exhibit 3.1.(Round discount factor(s) to three decimal places.)

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

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

Maurice is currently considering investing in a high dividend yield stock with no growth potential that pays a 6 percent dividend yield or bonds issued by the Coca-Cola Company that pay 8 percent.If Maurice's ordinary tax rate is 25 percent and his dividend tax rate is 15 percent, which investment should he choose? Which investment should he choose if his ordinary tax rate is 30 percent? At what ordinary tax rate would he be indifferent between the stock or the bond? What strategy is this decision based upon?

If Nicolai earns an 8 percent after-tax rate of return, $20,000 today would be worth how much to Nicolai in five years? Use future value of $1.(Round discount factor(s) to four decimal places.)

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.)

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

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

If Joel earns a 10 percent after-tax rate of return, $10,000 received in two years is worth how much today? Use Exhibit 3.1.(Round discount factor(s) to three decimal places.)

Susan Brown has decided that she would like to go back to school after her kids leave home in five years.To save for her education, Susan would like to invest $25,000 in an investment that provides a high return.If her marginal tax rate is 35 percent, what is Susan's after-tax rate of return for the following investment options? Qualified dividends are taxed at 15 percent. (1)Corporate bond issued at face value with 10 percent stated interest rate payable annually. (2)Dividend-paying stock with an annual qualifying dividend equal to 10 percent of her investment. (3)Growth stock with an annual growth rate of 8 percent and no dividends paid.(Round your interim calculations to the nearest whole number.)

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

The timing strategy becomes more attractive as tax rates decrease.

Which of the following increases the benefits of income deferral?

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

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?

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.

If Tom invests $60,000 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.