412 Advanced Tax Chapter 3 Exam 1

In order for a related-party transaction to be acceptable to the IRS, it should be structured as a(n) transaction.

Blank 1: arm's, arms, arm, or arms' Blank 2: length

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.

Blank 1: deduction, deductions, or deductible Blank 2: income

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

Blank 1: deferring, postponing, delaying, or defer

The tax planning strategy based on the understanding that the tax law does NOT treat all types of income and deductions the same is the strategy.

Conversion

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?

Corporate stock

Andrew received 20 percent of his business revenue in cash. The cash was not third-party reported to the IRS. Andrew has decided NOT to report the cash receipts on his tax return. Which response is true?

Failure to report the income is considered tax evasion.

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

False

The concept that $1 today is worth more than $1 in the future is known as:

present value

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. (Enter only one word per blank.)

present value

Generally, whenever a taxpayer can accelerate a tax deduction without accelerating the cash outflow, the strategy will be beneficial.

timing

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

timing

Using the attached table, what is the present value today of $2,300 received two years from now with a rate of return equal to 4%?

$2,300 x .925 = $2,127.50

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?

$550 x 0.952 = $523.60

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

.971

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

1/(1 +.06) = 0.943

Which one of the following statements is CORRECT regarding the timing strategy? Multiple choice question. It is best to recognize deductions in high-tax-rate years and income in low-tax-rate years. It is best to recognize income and deductions in high-tax-rate years. It is best to recognize deductions in low-tax-rate years and income in high-tax-rate years. It is best to recognize income and deductions in low-tax-rate years.

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

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.

Which of the following choices is an advantage of shifting income across jurisdictions? Multiple choice question. The IRS is likely to closely scrutinize companies who operate in multiple jurisdictions. Taxpayers often receive less scrutiny from the IRS when operating in multiple jurisdictions. The differences in tax rates and tax laws across jurisdictions can often be used to maximize after-tax wealth. The public is generally supportive of companies moving operations out of the U.S. in order to reap tax and other financial benefits.

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? (Check all that apply.) Multiple select question. When the actual receipt of the income does not have to be postponed very long When setting aside money for retirement When the rate of return on an investment is projected to increase When the taxpayer expects to be in a higher tax bracket in the future

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

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

accelerate; defer

step transaction doctrine

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

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

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

conversion

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

decreasing

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

deferring

When considering cash inflows, taxpayers and planners prefer present values that are (higher/lower) than the future value. When considering cash outflows, taxpayers and planners prefer present values that are (higher/lower) than the future value.

higher lower

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

The tax planning strategy known as shifting encompasses shifting earnings and deductions from (1) taxpayers in one rate bracket to taxpayers in a different rate bracket, and (2) one jurisdiction to a more tax favorable jurisdiction. (Enter only one word per blank.)

income

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

lower higher

Which of the following is NOT necessarily a part of effective tax planning? Multiple choice question. Minimizing tax payments Achieving nontax goals Maximizing after-tax wealth

Minimizing tax payments

Which of the following are tax planning methods used in income shifting strategies? (Check all that apply.) Multiple select question. Moving income and deductions to more tax favorable jurisdictions Accelerating deductions into an earlier year Moving income and deductions from taxpayers in one rate bracket to taxpayers in a different rate bracket Changing the form of income into a more tax-favored type of income

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

Which one of the following choices describes an income shifting tax planning strategy? Multiple choice question. Converting the type of income to a more tax favored source Deferring income to a low-tax-year Moving income to more tax favorable jurisdictions Accelerating tax deductions to a high-tax year

Moving income to more tax favorable jurisdictions

Which of the following methods will NOT result in a tax beneficial shift of income from a corporation to its employee-owner? Multiple choice question. Borrowing money from the employee-owner Renting property from the employee-owner Paying dividends to the employee-owner Paying compensation to the employee-owner

Paying dividends to the employee-owner

Which of the following methods will NOT result in a tax beneficial shift of income from a corporation to its employee-owner? Multiple choice question. Paying compensation to the employee-owner Renting property from the employee-owner Borrowing money from the employee-owner Paying dividends to the employee-owner

Paying dividends to the employee-owner

There are three basic tax planning strategies that represent the building blocks of tax planning. These strategies include , income shifting, and .

Blank 1: timing or time Blank 2: conversion

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%. Match the investment to its respective after-tax return. Instructions Corporate stock Corporate bonds Tax-exempt securities

212.50 201 200

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. (The answer should be in the form of amounts rather than words.)

5300

Which of the following statements is correct regarding present value? Multiple choice question. A $1 today is worth more than $1 in the future. A $1 today is worth less than $1 in the future. A $1 today is worth the same as $1 in the future. It would be better to receive $50 a year from now than to receive $50 today.

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

Which of the following taxpayers would likely benefit LEAST from an income shifting strategy? Multiple choice question. A taxpayer with a business that operates in one state A taxpayer that operates businesses in different jurisdictions A taxpayer that has family members with varying marginal rates

A taxpayer with a business that operates in one state

Select the two most important considerations that are necessary for effective tax planning for individuals. Multiple select question. Maximizing government revenue Achieving non-tax related goals Minimizing taxes Maximizing after-tax wealth

Achieving non-tax related goals Maximizing after-tax wealth

business purpose doctrine

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

substance over form doctrine

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

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.

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 $. (Round your answers to the nearest whole dollar.)

Blank 1: 2,400 or 2400 Blank 2: 2,299, 2299, 2,300, or 2300

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

Blank 1: taxpayer or taxpayers Blank 2: government, IRS, or irs

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

Constructive receipt

The strategy is based on the understanding that the tax law does not treat all types of income and deductions the same.

Conversion

Which of the following doctrines is NOT used by the IRS to examine transactions where it expects taxpayer abuse? Multiple choice question. Substance-over-form doctrine Tax minimization doctrine Economic substance doctrine Business purpose doctrine Step-transaction doctrine

Tax minimization doctrine

Which of the following statements is INCORRECT regarding tax planning? Multiple choice question. Tax planning is important because taxes are the primary determinant of how a transaction is structured. 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."

Tax planning is important because taxes are the primary determinant of how a transaction is structured.

Which of the following statements are CORRECT? (Choose all that apply.) Multiple select question. Taxpayers prefer lower present values when considering cash inflows. Taxpayers prefer lower present values when considering cash outflows. Taxpayers prefer higher present values when considering cash outflows. Taxpayers prefer higher present values when considering cash inflows.

Taxpayers prefer lower present values when considering cash outflows. Taxpayers prefer higher present values when considering cash inflows.

Which of the following statements is INCORRECT regarding income shifting strategies across jurisdictions? Multiple choice question. Although tax laws may be more favorable in other countries, negative publicity may hamper operations of companies who move operations overseas. Taxpayers that operate in multiple countries should always incorporate in the country with the lowest tax structure in order to pay taxes in that country. The differences in tax rates and tax laws across jurisdictions can often be used to maximize after-tax wealth. The IRS is likely to closely scrutinize companies who operate in multiple jurisdictions.

Taxpayers that operate in multiple countries should always incorporate in the country with the lowest tax structure in order to pay taxes in that country.

Which of the following statements is INCORRECT regarding income shifting strategies across jurisdictions? Multiple choice question. The differences in tax rates and tax laws across jurisdictions can often be used to maximize after-tax wealth. The IRS is likely to closely scrutinize companies who operate in multiple jurisdictions. Taxpayers that operate in multiple countries should always incorporate in the country with the lowest tax structure in order to pay taxes in that country. Although tax laws may be more favorable in other countries, negative publicity may hamper operations of companies who move operations overseas.

Taxpayers that operate in multiple countries should always incorporate in the country with the lowest tax structure in order to pay taxes in that country.

The taxpayers who are MOST likely to benefit from an income shifting strategy include which of the following choices? Multiple choice question. Taxpayers who have related parties with varying marginal tax rates or who operate in multiple jurisdictions with different marginal tax rates Taxpayers with multiple businesses operating in one jurisdiction where the tax rates are consistent Taxpayers who have family members with the same marginal rates that are willing to shift income for the benefit of the group

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

Which of the following options are limitations of a timing strategy? (Choose all that apply.) Multiple select question. The constructive receipt doctrine often prevents income from being deferred to a later period. Tax laws generally require taxpayers to continue their investment in an asset in order to defer income recognition. Taxpayers can sometimes choose to accelerate the recognition of tax deductible expense. The assignment of income doctrine dictates that the person/entity earning the income cannot assign the income and tax consequences to another.

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

Which of the following choices is an advantage of shifting income across jurisdictions? Multiple choice question. The IRS is likely to closely scrutinize companies who operate in multiple jurisdictions. Taxpayers often receive less scrutiny from the IRS when operating in multiple jurisdictions. The public is generally supportive of companies moving operations out of the U.S. in order to reap tax and other financial benefits. The differences in tax rates and tax laws across jurisdictions can often be used to maximize after-tax wealth.

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? Multiple choice question. Shelby switched her investments in corporate bonds to nontaxable, municipal bonds. 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. Tyler billed a client in January of Year 2 rather than December of Year 1 because he is expecting to be in a lower tax bracket for Year 2. Wyatt waited to pay his real property taxes for Year 1 until January of Year 2 so that he could take the tax deduction in Year 2.

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.

Economic substance doctrine

Transactions must meet two criteria Transaction must meaningfully change a taxpayer's economic position (excluding any federal income tax effects) Taxpayer must have a substantial purpose (other than tax avoidance) for the transaction

Which of the following transactions would NOT be acceptable to the IRS as a means of switching the taxable income to another taxpayer? Multiple choice question. Transferring interest income from a taxpayer's investment to his young daughter Selling a taxpayer's assets to her business at fair market value Giving a gift of the taxpayer's stock to her son

Transferring interest income from a taxpayer's investment to his young daughter

Under what circumstances might a taxpayer want to defer the recognition of income? (Check all that apply.) Multiple select question. When the taxpayer expects to be in a higher tax bracket in the future When the rate of return on an investment is projected to increase When setting aside money for retirement When the actual receipt of the income does not have to be postponed very long

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

Under which of the following situations is a strategy for the timing of deductions most beneficial? (Check all that apply.) Multiple select question. When the taxpayer is expecting to be taxed at a higher rate in the future When tax rates are high When tax deductions can be accelerated without accelerating the cash outflow When the transaction is large When the taxpayer is earning a high rate of return When tax rates are low When the transaction is small

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