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