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Exam 3: Tax Planning Strategies and Related Limitations

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Question 41

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If Julius has a 30% tax rate and a 10% after-tax rate of return,a $40,000 tax deduction in two years will save how much tax in today's dollars? Use Exhibit 3.1 in the text.(Round present and future value amounts to 3 places)

A) $40,000.
B) $9,912.
C) $33,040.
D) $12,000.
E) None of the choices are correct.

F) A) and E)
G) None of the above

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Question 42

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Effective tax planning requires all of these considerations except:

A) nontax factors.
B) the taxpayer's tax costs of alternative transactions.
C) the other party's tax costs of alternative transactions.
D) the other party's nontax costs of alternative transactions.
E) all of the choices are required considerations.

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

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Question 43

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Tax savings generated from deductions are considered cash inflows.

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? Use Exhibit 3.1 in the text.

Assume that Will's marginal tax rate is 32% and his tax rate on dividends is 15%.If a dividend-paying stock (with no growth potential) pays a dividend yield of 8%,what interest rate must the corporate bond offer for Will to be indifferent between the two investments from a cash-flow perspective?

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

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?

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

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.

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

Which of the following is needed to implement the income shifting strategy?

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?

The time value of money suggests that $1 in one year from now is worth less than $1 today.

Lucinda is contemplating a long range planning strategy that will allow her to defer sizable portions of her income for 10 years.What type of planning strategy is she contemplating? What are some potential risks associated with this type of strategy?

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? Use Exhibit 3.1 in the text. 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 downside of tax avoidance includes the potential of stiff monetary penalties and imprisonment.

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% dividend yield or bonds issued by The Coca Cola Company that pay 8%.If Maurice's ordinary tax rate is 25% and his dividend tax rate is 15%,which investment should he choose? Which investment should he choose if his ordinary tax rate is 30%? At what ordinary tax rate would he be indifferent to the stock or to the bond? What strategy is this decision based upon?

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

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