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Exam 3: Tax Planning Strategies and Related Limitations

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Question 1

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A taxpayer paying his 10-year-old daughter $50,000 a year for consulting likely violates which doctrine?

A) Constructive receipt doctrine.
B) Implicit tax doctrine.
C) Substance-over-form doctrine.
D) Step-transaction doctrine.
E) None of the choices are correct.

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

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Question 2

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Assume that Keisha's marginal tax rate is 37 percent and her tax rate on dividends is 15 percent. If a city of Atlanta bond pays 7.65 percent interest, what dividend yield would a dividend-paying stock (with no growth potential) have to offer for Keisha to be indifferent between the two investments from a cash-flow perspective?

A) 15.00 percent.
B) 10.00 percent.
C) 9) 00 percent.
D) 7) 65 percent.
E) None of the choices are correct.

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

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Question 3

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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.)

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

Rolando's employer pays year-end bonuses each year on December 31. Rolando, a cash-basis taxpayer, would prefer not to pay tax on his bonus this year. So, he leaves town on December 31, 2018, and doesn't pick up his check until January 2, 2019. When should Rolando report his bonus?

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?

In general, tax planners prefer to defer income. This is an example of the conversion strategy.

Assume that Lavonia's marginal tax rate is 22 percent. If a city of Tampa bond pays 5 percent interest, what interest rate would a corporate bond have to offer for Lavonia to be indifferent between the two bonds?

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

Which is not a basic tax planning strategy?

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

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

If Jim invested $100,000 in an annual dividend-paying stock today with a 7 percent return, what investment time period will give Jim the greatest after-tax return?

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

David, an attorney and cash-basis taxpayer, is new to the concept of tax planning and recently learned of the timing strategy. To implement the timing strategy, David plans to establish a new policy that allows his clients to wait up to five years to pay their attorney fees. Assume that David expects his marginal tax rates to remain constant over the foreseeable future. What is wrong with this strategy?

Assume that Bill's marginal tax rate is 32 percent. If corporate bonds pay 8 percent interest, what interest rate would a municipal bond have to offer for Bill to be indifferent between the two bonds?

Based only on the information provided for each scenario, determine whether Eddy or Scott will benefit more from using the timing strategy and why there will be a benefit to that person. Use Exhibit 3.1. a. Eddy has a 40 percent tax rate. Scott has a 30 percent tax rate. b. Eddy and Scott each have a 40 percent tax rate. Eddy has $10,000 of income that could be deferred; Scott has $20,000 of income that could be shifted. c. Eddy and Scott each have a 40 percent tax rate and $20,000 of income that could be deferred. Eddy's after-tax rate of return is 8 percent. Scott's after-tax rate of return is 10 percent. d. Eddy and Scott each have a 40 percent tax rate, $20,000 of income that could be deferred, and an after-tax rate of return of 10 percent. Eddy can defer income up to three years. Scott can defer income up to two years.

If Rudy has a 25 percent tax rate and a 6 percent after-tax rate of return, a $30,000 tax deduction in four years will save how much tax in today's dollars? Use Exhibit 3.1. (Round discount factor(s) to three decimal places.)

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 32 percent this year and 37 percent next year and that he can earn an after-tax rate of return of 12 percent on his investments. Should Sal send his client the bill in December or January? Use Exhibit 3.1. (Round discount factor(s)to three decimal places.)

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.)