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Exam 3: Tax Planning Strategies and Related Limitations

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Question 31

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Investing in municipal bonds to avoid paying tax on interest earned and to earn a higher after-tax yield is an example of:

A) conversion.
B) tax evasion.
C) timing.
D) income shifting.
E) None of the choices are correct.

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

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Question 32

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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.

A) $88,647; $159,198.
B) $92,782; $178,414.
C) $79,621; $121,716.
D) $77,495; $113,750.
E) None of the choices are correct.

F) B) and D)
G) A) and B)

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Question 33

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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.

The income shifting strategy requires taxpayers with varying tax rates.

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

If Nicolai earns an 8% after-tax rate of return, $20,000 today would be worth how much to Nicolai in 5 years? Use Future value of $1. (Round present and future value factor(s) to 5 decimal places.)

Boeing is considering opening a plant in two neighboring states. One state has a corporate tax rate of 15%. If operated in this state, the plant is expected to generate $1,200,000 pre-tax profit. The other state has a corporate tax rate of 5%. If operated in this state, the plant is expected to generate $1,085,000 of pre-tax profit. Which state should Boeing choose based upon tax considerations only? Why do you think the plant in the state with a lower tax rate would produce a lower pre-tax income?

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?

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

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?

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

If Joel earns a 10% after-tax rate of return, $10,000 received in two years is worth how much today? Use Exhibit 3.1. (Round present and future value amounts to 3 places)

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?

Which of the following does not limit the benefits of deferring income?

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 2018 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? (Use tax rate schedule) Note: New Corporate income tax rate has been mentioned as "21% on all taxable income" as per the recent change.

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

Luther was very excited to hear about the potential tax savings from shifting income from his corporation to him. The next day he had his corporation declare a $30,000 dividend to him. Is this an effective income shifting strategy? If so, why? If not, why not? What recommendations do you have for Luther?

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

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

Assume that Juanita is indifferent between investing in a corporate bond that pays 10.20% 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?