Chapter 3 Smartbook

Darlene plans to purchase $3,000 in furniture for her office. She is currently in the 20% tax bracket, so her after tax cost of the furniture is _____ if she purchases it in the current year. She expects her marginal rate will increase to 25% next year. If she waits until next year to purchase the furniture and her after tax rate of return is 7%, the after-tax cost of her furniture will be $.

$2400; $2300

Lucky Lee has won a contest where he can choose to receive $500 today or $550 one year from now. Assuming his rate of return is 5%, how much is the $550 worth today?

$523.60 Reason: $550 x .952 = $523.60

Which of the following transactions would be acceptable to the IRS as a means of switching the taxable income to another taxpayer?

-Giving a gift of the taxpayer's stock to her son -Selling a taxpayer's assets to her business at fair market value

Which of the following are tax planning methods used in income shifting strategies?

-Moving income and deductions from taxpayers in one rate bracket to taxpayers in a different rate bracket -Moving income and deductions to more tax favorable jurisdictions

Calculate the discount factor for one period for an investment given a rate of return equal to 6 percent.

0.943

The discount factor for a one-year investment earning a rate of return of 3 percent is equal to _____

0.971

Which of the following statements is correct regarding present value?

A $1 today is worth more than $1 in the future.

Which one of the following statements is CORRECT regarding the timing strategy?

It is best to recognize deductions in high-tax-rate years and income in low-tax-rate years.

Which of the following choices is an advantage of shifting income across jurisdictions?

The differences in tax rates and tax laws across jurisdictions can often be used to maximize after-tax wealth.

How should a taxpayer evaluate whether it is advantageous to accelerate a tax deduction in a period of tax rate increases?

The taxpayer needs to compare the tax-savings from the deduction in the current year to the present value of the tax-savings in one year.

Which of the following taxpayers is using an income shifting tax planning strategy?

Tori (33% marginal tax rate) gave several of her investments to her daughter so that the income will be taxed at the daughter's lower tax rate.

An effective income shifting strategy for a corporation and an employee-owner involves generating a tax _____ for one party while generating taxable _____ for the other party.

deduction; income

In addition to accelerating deductions, the timing strategy of _____ income recognition is beneficial to many taxpayers

deferring

When tax rates are constant, tax planning suggests that taxpayers should consider _____ the recognition of income.

deferring

Tax _____ is the legal act of arranging one's transactions to minimize taxes paid. Tax _____ is the willful act of defrauding the government by NOT paying taxes legally owed.

avoidance; evasion

Conversion

changing the type of income to a more tax-favored form of income

When tax rates are constant or _____, taxpayers should accelerate tax deductions and defer taxable income.

decreasing

Which of the following taxpayers would likely benefit LEAST from an income shifting strategy?

A taxpayer with a business that operates in one state

Business purpose doctrine

Allows the IRS to challenge and disallow business expenses with no underlying business motivation

Step-transaction doctrine

Allows the IRS to collapse a series of related transactions into one transaction to determine the tax consequences

Substance over form doctrine

Allows the IRS to consider the purpose of the transaction regardless of the way it is structured

Which of the following methods will result in a tax beneficial shift of income from a corporation to its employee-owner?

Borrowing money from the employee-owner Renting property from the employee-owner Paying compensation to the employee-owner

Which of the following is NOT necessarily a part of effective tax planning?

Minimizing tax payments

Economic substance doctrine

Requires the transaction to meet two criteria: (1) meaningfully change a taxpayer's economic position and (2) have a substantial purpose for the transaction

Which of the following doctrines ARE used by the IRS to examine transactions where it expects taxpayer abuse?

Step-transaction doctrine Economic substance doctrine Substance-over-form doctrine Business purpose doctrine

Which of the following options best describes the basis for conversion strategies?

The understanding that the tax law does not treat all types of income and deductions the same

Under which of the following situations is a strategy for the timing of deductions most beneficial?

When tax deductions can be accelerated without accelerating the cash outflow When tax rates are high When the taxpayer is earning a high rate of return When the transaction is large

Because it often restricts the income deferral for cash-method taxpayers, the __________ doctrine is a limitation of a timing strategy.

constructive receipt

Limitations on certain tax benefits, such as depreciation for luxury automobiles, often decrease or eliminate the benefits of _____ strategies.

conversion

When considering cash inflows, taxpayers and planners prefer present values that are _____ than the future value. When considering cash outflows, taxpayers and planners prefer present values that are _____ than the future value.

higher; lower

When tax rates are constant, taxpayers should ______ tax deductions and ______ recognizing taxable income.

accelerate; defer

When tax rates are decreasing, taxpayers should _____ tax deductions and _____ taxable income

accelerate; defer

What is the name of the tax rule that requires income to be taxed to the taxpayer who actually earns it?

assignment of income doctrine

The tax planning strategy that involves deferring or accelerating taxable income and tax deductions is:

timing

Andre has the option of receiving $1,800 today or $1,860 a year from now. Assuming Andre can invest the money and earn 4% this year, he would have _____ a year from now. He should take the _____

$1872; $1800

Nina can choose to receive $5,000 today or $5,000 a year from now. If she takes the money now and invests the money at a 6% interest rate (after tax), she will have _____ one year from now.

$5300 Reason: $5000 x 1.06 = $5300

Which of the following statements ARE CORRECT regarding tax planning?

-Tax planning requires understanding that almost every financial transaction includes the taxpayer, the other transacting party, and the government. -Good tax planning requires understanding the tax and nontax costs from the taxpayer's and the other party's perspective. -The government is involved in most all transactions between two parties and is sometimes referred to as "the uninvited silent party."

Which of the following statements ARE CORRECT regarding income shifting strategies across jurisdictions?

-The IRS is likely to closely scrutinize companies who operate in multiple jurisdictions. -Although tax laws may be more favorable in other countries, negative publicity may hamper operations of companies who move operations overseas. -The differences in tax rates and tax laws across jurisdictions can often be used to maximize after-tax wealth.

Under what circumstances might a taxpayer want to defer the recognition of income?

-When setting aside money for retirement -When the actual receipt of the income does not have to be postponed very long

Amanda decided to wait to sell her investment in ABC, Inc. until she had owned the stock for more than one year. Because she waited, she was able to pay tax on the gain at a lower rate than her marginal rate. Which of the following choices best describes the result of Amanda's decision?

Amanda's decision to postpone the sale to receive more favorable tax treatment is considered tax avoidance and is legal.

Which of the following tax planning strategies is based on the understanding that the tax law does NOT treat all types of income and deductions the same?

Conversion strategy

Andy is considering investing $5,000 into one of three investments. He can invest in corporate stock that will pay dividends of 5% per year. He can purchase corporate bonds that pay 6%. Or, he can invest in tax-exempt securities that will pay 4% per year. Andy is in the 33% marginal tax bracket and the dividends will be taxed at 15%. Based on his after-tax return, which investment should he choose? Match the investment to its respective after-tax return.

Corporate stock Corporate stock = 212.50 Corporate bonds = 201.00 Tax-exempt securities = 200.00

The primary purpose of effective tax planning is to minimize taxable income, thus minimizing a taxpayer's tax liability for the year.

False

Which of the following options are limitations of a timing strategy?

Tax laws generally require taxpayers to continue their investment in an asset in order to defer income recognition. The constructive receipt doctrine often prevents income from being deferred to a later period.

The taxpayers who are MOST likely to benefit from an income shifting strategy include which of the following choices?

Taxpayers who have related parties with varying marginal tax rates or who operate in multiple jurisdictions with different marginal tax rates

Danny is trying to determine if he should purchase equipment for his business this year or next year. He is currently in the 28% tax bracket and will be able to expense the equipment in the year he purchases it. With the new equipment, he believes that his marginal rate will increase to 33% next year. The cost of the equipment is $20,000 and his after-tax rate of return is 6%. Calculate the after-tax cost of the equipment for both years and choose the correct statement below.

The after tax cost of the equipment is $14,400 this year or $13,776 next year. Danny should purchase the equipment next year.

Timing

accelerating tax deductions and deferring the recognition of taxable income

A lower rate of return on tax-exempt securities than the rate earned on similar taxable securities is an example of a(n) _____ tax which often reduces or negates the benefits of conversion strategies.

implicit

All other things being equal, taxpayers should prefer to recognize income during _____ tax-rate years and deductions during _____ tax-rate years.

low; high

Income shifting

moving income and deductions from taxpayers in one tax bracket to taxpayers in a different tax bracket

The impact of the tax rate on a transaction must be considered along with the __________ of the transaction to determine if the benefits of accelerating the transaction outweigh the disadvantages.

present value

Every transaction includes three parties: the _____, the other transacting party, and the _____

taxpayer; government