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Exam 3: Tax Planning Strategies and Related Limitations

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Question 1

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

A) True
B) False

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Question 2

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

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Question 3

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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?

The constructive receipt doctrine is more of an issue for cash basis taxpayers.

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?

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?

Assume that John's marginal tax rate is 40%. If a city of Austin bond pays 6% interest, what interest rate would a corporate bond have to offer for John to be indifferent between the two bonds?

Jayzee is a single taxpayer who operates a sole proprietorship. He expects his taxable income next year to be $150,000, of which $125,000 is attributed to his sole proprietorship. Jayzee is contemplating incorporating his sole proprietorship. Using the 2014 single individual tax brackets and the corporate tax brackets, how much current tax could this strategy save Jayzee? (Ignore any Social Security, Medicare, or Self Employment Tax issues.) How much income should be retained in the corporation?

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

If tax rates will be higher next year, taxpayers should accelerate their deductions regardless of their after-tax rate of return.

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?

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

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

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?

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.

Jason's employer pays year-end bonuses each year on December 31. Jason, a cash basis taxpayer, would prefer to not pay tax on his bonus this year (and actually would prefer his daughter to pay tax on the bonus) . So, he leaves town on December 31, 2014 and has his daughter, Julie, pick up his check on January 2nd, 2015. Who reports the income and when?

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

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 Jose is indifferent between investing in a corporate bond that pays 10% interest and a stock with no growth potential that pays an 8% dividend yield. Assume that the tax rate on dividends is 15%. What is Jose's marginal tax rate?

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?