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Exam 3: Tax Planning Strategies and Related Limitations

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Question 51

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

A) True
B) False

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Question 52

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Bobby and Whitney are husband and wife and Whitney operates a sole proprietorship. They expect their joint taxable income next year to be $200,000, of which $125,000 is attributed to the sole proprietorship. Whitney is contemplating incorporating the sole proprietorship. Using the 2014 married filing joint tax brackets and the corporate tax brackets, how much current tax could this strategy save Bobby and Whitney? How much income should be retained in the corporation?

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Assuming Bobby and Whitney's goal is to ...

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Question 53

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

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.

The timing strategy is particularly effective for cash basis taxpayers.

Which of the following strategies is based on the present value of money?

The conversion strategy capitalizes on the fact that tax rates vary across different activities.

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. a. Kristi has a 40% tax rate and can defer $20,000 of income. Cindy has a 30% tax rate and can defer $30,000 of income. b. Kristy has a 30% tax rate, a 10% after-tax rate of return, and can defer $25,000 of income for three years. Cindy has a 40% tax rate, an 8% after-tax rate of return, and can defer $20,000 of income for four years.

Tax savings generated from deductions are considered cash inflows.

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

Assume that Lucas' marginal tax rate is 30% and his tax rate on dividends is 15%. If a dividend-paying stock (with no growth potential) pays an 8% dividend yield, what interest rate would a municipal bond have to offer for Lucas to be indifferent between the two investments?

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

Rolando's employer pays year-end bonuses each year on December 31. Rolando, a cash basis taxpayer, would prefer to not pay tax on his bonus this year. So, he leaves town on December 31, 2014 and doesn't pick up his check until January 2nd, 2015. When should Rolando report his bonus?

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

Implicit taxes may reduce the benefits of the conversion strategy.

If tax rates are decreasing:

Antonella works for a company that pays a year-end bonus in December of each year. Assume that Antonella expects to receive a $20,000 bonus in December this year, her tax rate is 30%, and her after-tax rate of return is 8%. If Antonella's employer paid her bonus on January 1 of next year instead of December, how much would this action save Antonella in today's tax dollars? If Antonella's tax rate increased to 32% next year, would receiving the bonus in January still be advantageous?

If Scott earns a 12% after-tax rate of return, $15,000 today would be worth how much to Scott in 2 years?

Sal, a calendar year taxpayer, uses the cash-basis method of accounting for his sole proprietorship. In late December he performed $40,000 of consulting services for a client. Sal typically requires his clients to pay his bills immediately upon receipt. Assume that Sal's marginal tax rate is 30% this year and 35% next year and that he can earn an after-tax rate of return of 12% on his investments. Should Sal send his client the bill in December or January?