Chapter 3: Tax Planning Strategies and Related Limitations
Virtually, every transaction includes how may partes?
3
Step transaction doctrine:
Allows IRS to collapse a series of related transactions into one transaction to determine the tax consequences of the transaction
after tax rate of return =
Before Tax Rate of Return * (1 - marginal tax rate)
Limitation of conversion strategies
IRC contains specific provisions that prevent TPs from changing the nature of expenses, income, or activities to a more tax advantaged status implicit taxes may reduce or eliminate the advantages or conversion strategies
limitations of income shifting across jurisdictions
IRS closely examines transfer pricing on internal transactions state tax authorities scrutinize interstate transactions between related taxpayers when TP located in low tax rate jurisdiction shifts income to a tax advantaged jurisdiction, they may bear implicit taxes
after tax rate of return:
a taxpayer's before rate of return on an investment minus the taxes paid on the income from the investment
Timing strategy: When tax rates are constant, ______________ tax deductions and ____________________ taxable income
accelerate tax deductions defer recognizing taxable income
When tax rates are decreasing, what should taxpayers do?
accelerate tax deductions into earlier years defer taxable income into later years
implicit taxes of income shifting across jurisdictions
additional costs attributable to jd tax advantage
The time when income is taxed or an expense is deducted affects what
affects the present value of the taxes paid on income or the tax savings on deductions
Example of income shifting across jurisdictions
allocating a portion of overhead from different locations
business purpose doctrine:
allows IRS to challenge and disallow business expenses for transactions with no underlying business motivation
substance over form doctrine:
allows the IRS to consider the transaction's substance regardless of its form and, where appropriate, to reclassify the transaction according to its substance
limitation of related party income shifting
assignment of income doctrine
The three tax planning strategies fall into tax __________-
avoidance
Effective tax planning requires a basic understanding of what
basic understanding of the roles that tax and nontax factors play in structuring business, investment, and personal decisions
Additional limitations to tax planning strategies
business purpose doctrine step transaction doctrine substance over form doctrine economic substance doctrine BSSE
How to analyze the benefits of a conversion strategy
compare the after tax rates of return of alternative investments rather than the before tax rates of return
What is the most common method for a corporation to create a tax deduction for itself?
compensation expense compensation expense is deductible
Methods for a corporation to create a tax deduction for itself?
compensation expense business owners rents property to corporation owner lends money to corporation
conversion:
converting income from high to low rate activities
In order to shift income from corporation to owner, what must happen?
corporation must create a tax deduction for itself in the process
When tax rates are constant, why would we accelerate tax deductions?
deducting in an earlier period increases the present value of the tax savings from the deduction tax savings received now have a higher present value than the same amount received a year from how
When tax rates are constant, tax planners prefer to _________ income and ____________ deductions
defer; accelerate
timing:
deferring or accelerating taxable income and tax deductions
IRS encourages related person transactions t/f
false IRS scrutinizes related person transactions
related person transactions:
financial activities among family members
Timing strategy may not be good if continuing an investment would _______
give a low rate of return compared to other investments
Example of income shifting between family members
high rate tax parent shifting income to low tax rate child
income shifting is to shift income from _______ tax rate taxpayers to ____________ tax rate taxpayers
high tax rate taxpayers to low rate taxpayers
TP should prefer to recognize deductions during ________ tax rate years and recognize income during ________ tax rate hears
high;low
When considering cash inflows, ________ present values are preferred
higher
the higher the tax rate, the _________ the tax savings for a tax deduction
higher
____________ may reduce or eliminate the advantages or conversion strategies
implicit taxes
Examples of conversion strategy
income and deductions with differing character investments generating income subject to different tax rates expenses with differing deductibility
tax savings are cash ________
inflows
Tax avoidance:
legal act of arranging your transactions to minimize taxes paid
constructive receipt doctrine is a limitation/benefit of timing strategies
limiation
Income shifting is to shift deductions from ________ tax rate taxpayers to _________tax rate taxpayers
low tax rate TP to high rate TP
the lower the tax rate, the ____________the tax costs for taxable income
lower
when we are considering cash outflows, __________ present values are preferred
lower
What is the goal of effective tax planning?
maximizing the taxpayer's after tax wealth while achieving the taxpayer's non tax goals
taxes paid are cash __________
outflows
Income shifting is common between who?
owners and their businesses
constructive receipt doctrine:
provides that a TP must recognize income when it is actually received. Deemed to have occurred if income has been credited to TP account
When tax rates are constant, why would we defer recognizing taxable income?
recognizing taxable income in a later period minimizes the present value of taxes paid
What taxpayers benefit from income shifting strategies?
related parties taxpayers operating in multiple jurisdictions
assignment of income doctrine:
requires income to be taxed to the TP who actually earns it
economic substance doctrine:
requires transactions to meet two criteria to obtain its benefits transaction must meaningfully change a taxpayer's economic position TP must have a substantial purpose for the transaction
Strategy for income shifting across jurisdictions
shifting income from high tax jurisdiction to low tax jurisdictions
income shifting:
shifting income from high to low rate taxpayers
maximizing after tax wealth requires us to consider what?
tax costs and benefits non tax costs and benefits
tax savings are generated from what
tax deductions
________________ can vary across different activities
tax rates
What parties does every transaction have?
taxpayer other transaction party uninvited silent party - government
When tax rates are increasing, what should taxpayer do?
taxpayer must calculate the optimal tax strategies for deductions and income
Conversion strategy is based on the understand that ________
the tax law does not treat all types of income or deductions the same
What are the basic tax planning strategies?
timing income shifting conversion
dividends is not an effective income shifting strategy t/f
true
maximizing after tax wealth is not the same things as minimizing taxes t/f
true
When would a timing strategy be less beneficial
when TP is unable to accelerate a deduction without also accelerating the cash outflow
tax evasion:
willful attempt to defraud the government by not paying taxes legally owed
if income is unconditionally available to the taxpayer, does the constructive receipt doctrine apply
yes it applies