Econ 138A ch 3, 4

Which of the following types of income are subject to a preferential rate? (Select all that apply.) Interest income Ordinary business income Capital gains Interest from municipal bonds

Capital gains Interest from municipal bonds

tax law uncertainty

Reflects the likelihood that tax law may change relative to what the taxpayer anticipated

capital gains tax treatment

Taxed at a preferential rate

explicit tax

The direct tax paid to the taxing authority

time period variable

during which tax year(s) does the transaction occur?

jurisdiction vairable

in which tax jurisdiction does the transaction occur?

to calculate the preferential rate

multiply the annual return on investment by the difference between the marginal tax rate on ordinary income and the capital gain tax ch4 #20

entity vairable

which entity undertakes the transaction?

Company A and B are members of the same controlled group. Company A is located in Jurisdiction A which levies a 20% tax on income. Company B is located in Jurisdiction B which levies a 30% tax on income. If a transaction is structured such that $100,000 of income is shifted from Company B to Company A, the resulting tax savings is

$10,000

James sold an investment for $100,000 that he originally purchased for $80,000. Because he held the investment for 5 years, the gain qualifies for a 15% preferential rate. His marginal tax rate on ordinary income is 25%. The tax savings from the preferential rate is

$2000

Mr. Silver made a gift to his 20-year old son, Hunt. The gift consisted of 100 shares of Giggle stock. Mr. Silver's marginal tax rate is 37% and Hunt's marginal tax rate is 12%. Which of the following statements is true? The tax obligation related to the dividend will be greater after the transfer. Reason: The tax obligation after the transfer will be less because it will now be taxed to Hunt. Hunt must include the dividend income in his taxable income. Reason: Because the asset was transferred, the income is now taxable to Hunt. Mr. Silver must include the dividend income in his taxable income. Reason: Because the asset was transferred, the income is now taxable to Hunt.

Hunt must include the dividend income in his taxable income. Reason: Because the asset was transferred, the income is now taxable to Hunt.

Which of the following statements is false regarding income and deduction shifting? Income shifting is illegal regardless of whether the underlying transaction has a genuine business purpose. Reason: Income shifting is illegal when there is no genuine business purpose. Income and deduction shifting techniques result in lower tax revenues for the government. The IRS more heavily scrutinizes related party transactions for income and deduction shifting practices. Reason: The IRS more heavily scrutinizes related party transactions because income shifting is more easily structured between related parties.

Income shifting is illegal regardless of whether the underlying transaction has a genuine business purpose. Reason: Income shifting is illegal when there is no genuine business purpose.

Which of the following is not a taxable entity for U.S. federal income tax purposes? Estate Individual Partnership Corporation

Partnership

Which of the following statements about tax strategies is false? Tax planners should prefer a flexible strategy over an inflexible strategy. Tax planners should consider both the tax and the non-tax costs. Tax planners should consider the tax consequences of a tax strategy to all parties involved in the transaction.

Tax planners should consider both the tax and the non-tax costs.

Which of the following statements about tax legal doctrines is false? The economic substance, business purpose, substance over form, and step transaction doctrines increase uncertainty of the tax law. Taxpayers can invoke the substance over form doctrine to undo the tax consequence of a failed planning strategy. The scope of economic substance, business purpose, substance over form, and step transaction doctrines often overlap. The IRS application of doctrines is subjective.

Taxpayers can invoke the substance over form doctrine to undo the tax consequence of a failed planning strategy. Reason: Taxpayers may not invoke any of the doctrines to undo a failed tax strategy.

Which of the following statements about private market transactions is true? Unlike public markets, transacting parties have the opportunity for bilateral tax planning. The negotiating parties do not have flexibility in determining the financial and legal structure of the transaction. Negotiating parties are prevented from direct negotiation.

Unlike public markets, transacting parties have the opportunity for bilateral tax planning.

character variable

What is the tax character (determined by law) of the income from the transaction?

YaBlue Company is structuring a transaction that will generate $1 million in taxable revenues and cash inflow. Which of the following structures is most effective in terms of the time period variable? YaBlue will receive the cash and report the related taxable income in the current year. Reason: The most effective approach is to receive cash currently, while deferring the tax payment. YaBlue will report the related taxable income in the current year and receive the cash in the following year. Reason: The most effective approach is to receive cash currently, while deferring the tax payment. YaBlue will receive the cash and report the related taxable income in the following year. Reason: The most effective approach is to receive cash currently, while deferring the tax payment. YaBlue will receive the cash in the current year and report the related taxable income in the following year.

YaBlue will receive the cash in the current year and report the related taxable income in the following year.

The time period variable reflects the fact that ______. tax planning is always a multi-year process Reason: The time period variable focuses on the net present value associated with the timing of tax cash flows. a tax dollar paid today costs more in present value terms than a tax dollar paid in the future when tax planning, the timing of deductions is more relevant than the timing of income

a tax dollar paid today costs more in present value terms than a tax dollar paid in the future

The arm's-length transaction presumption ______. is assumed to be satisfied in related party transactions Reason: It is not assumed to be satisfied. can never be satisfied if two parties employ tax planning techniques in their negotiations Reason: The IRS accepts favorable tax consequences negotiated in an arms-length transaction because an arms-length transaction is presumed to reflect economic reality. assumes each party is dealing in its own economic self-interest

assumes each party is dealing in its own economic self-interest

Rally Corporation has been advised by its accountant to deduct an expenditure that the IRS has disallowed for other corporations in similar circumstances. If Rally decides not to take the deduction, Rally is most directly minimizing ______. business risk tax law uncertainty marginal tax rate uncertainty audit risk

audit risk

Choice, The Halls were denied a deduction for the cost of a trip to the Caymans. The IRS held that the trip was a vacation and there was no evidence that the reason for the trip was to attend a professional conference. The Halls were denied a deduction for the cost of a trip to the Caymans. The IRS held that the trip was a vacation and there was no evidence that the reason for the trip was to attend a professional conference.

business purpose doctrine

Jeremy decided to liquidate his investment in Plaka Corporation bonds. He reinvested the proceeds in City of Arlington municipal bonds. This tax planning strategy may be taking advantage of the ______. entity variable jurisdiction variable time period variable character variable

character variable

Tax costs ______ and cash flows ______ when taxable income is shifted to an entity subject to a ______ tax rate. decrease; increase; lower decrease; decrease; lower decrease; increase; higher increase; increase; lower

decrease; increase; lower

In present value terms, tax costs ______ and cash flows ______ when income is shifted to a ______ taxed time period. decrease; do not change; lower decrease; decrease; higher increase; decrease; higher increase; decrease; lower

increase; decrease; higher

As the marginal tax rate increases, the tax savings associated with an expenditure ______ and the after-tax cost of the expenditure ______. increases, decreases decreases, decreases decreases, increases increases, increases does not change, does not change

increases, decreases

As the marginal tax rate increases, the tax savings associated with an expenditure ______ and the after-tax cost of the expenditure ______. increases, decreases decreases, increases increases, increases decreases, decreases does not change, does not change

increases, decreases

if calculating the tax cost of additional income

multiply the additional income by the percent unless: the firm has a loss of income for the year, then subtract that amount from the additional income and then multiply that by the percent ch3 #6

a gift of rental property: to calculate tax savings

multiply the annual income by the difference between each person's tax rate this goes for any gift in which the gifter gives the other person rights to the item (eg corporate bond) ch4 #4

when calculating tax savings

multiply the deductible expense by the percent if that deduction moves its tax bracket, separate into two if the company has a net loss there is no tax savings ch3 #7

The U.S. income tax structure ______. (Select all that apply.) has one rate structure that applies to all types of taxpaying entities Reason: Different tax rate structures exist for corporations and for individuals. provides for opportunities to tax plan using differences in tax rates and provisions across entities includes similar provisions for the computation of taxable business income across all taxable entities

provides for opportunities to tax plan using differences in tax rates and provisions across entities includes similar provisions for the computation of taxable business income across all taxable entities

Income shifting techniques ______. (Select all that apply.) result in reduced tax revenues for the government are more easily arranged between related parties are prevalent because no rules exist to curtail this type of activity Reason: Congress has enacted several statutory restrictions designed to limit the ability to shift income without a business purpose. may be disallowed if there is no business purpose other than tax avoidance

result in reduced tax revenues for the government are more easily arranged between related parties may be disallowed if there is no business purpose other than tax avoidance

First Corp. sold an asset to an unrelated company, Next Corp. Next Corp. immediately sold the asset to Final Corp. which is a controlled subsidiary of First Corp. Upon audit, the IRS collapsed the two sales into one sale for tax purposes, First Corp to Final Corp.

step transaction doctrine

The Joiners have a daughter attending college in Miami. They own an advertising business in LA. They have asked the controller to send a monthly paycheck from the business to their daughter. The daughter performs no services for the advertising business. Upon audit, the IRS disallows the company's compensation deduction and reclassifies the payment as a dividend to the Joiners and a subsequent gift to the daughter.

substance over form doctrine

Interest income other than municipal bond interest tax treatment

taxed at ordinary rates

a gift of interest coupon from a corporate bond

there are no tax savings because the gifter retains ownership of the bond this goes for any gift in which the gifter retain ownership (eg: rent income) ch4 #4

Which of the following statements best describes implicit and explicit taxes? The amount of an implicit tax is dependent on the taxpayer's marginal tax rate. Reason: Implicit tax is a reduced before-tax rate of return on a tax-favored investment. An explicit tax is the tax paid to the taxing jurisdiction. A taxpayer should prefer a $100 implicit tax over a $100 explicit tax. Reason: A taxpayer is neutral with respect to paying an identical amount of implicit or explicit tax.

An explicit tax is the tax paid to the taxing jurisdiction.

Which of the following statements about marginal tax rates is false? As the marginal tax rate increases, the tax cost of an income generating transaction decreases. The marginal tax rate can change over time and across transactions. As the marginal tax rate increases, the tax savings from a deduction increases.

As the marginal tax rate increases, the tax cost of an income generating transaction decreases. Reason: As the marginal tax rate increases, the tax cost of an income generating transaction increases.

Which of the following statements about marginal tax rates is false? As the marginal tax rate increases, the tax savings from a deduction increases. The marginal tax rate can change over time and across transactions. As the marginal tax rate increases, the tax cost of an income generating transaction decreases.

As the marginal tax rate increases, the tax cost of an income generating transaction decreases. Reason: As the marginal tax rate increases, the tax cost of an income generating transaction increases.

Which of the following statements most accurately describes audit risk? The tax law is always clear with respect to application of the law. Therefore, audit risk is solely a reflection of negligence by the taxpayer. Reason: Tax law is often ambiguous. This is especially true in the period immediately after new legislation is passed. Accepting audit risk by taking an aggressive position is costless as long as the taxpayer ultimately wins the challenge by the IRS in court. Reason: It is not costless because, for example, the cost of litigating can be high. Audit risk reflects the risk that the IRS may interpret or apply the law to a transaction differently than the position taken by the taxpayer.

Audit risk reflects the risk that the IRS may interpret or apply the law to a transaction differently than the position taken by the taxpayer.

C Corp has two subsidiaries, B Corp and D Corp. Assume the three entities have the following marginal tax rates: C Corp (36%) D Corp (21%) B Corp (10%) The related group is contemplating an expenditure that any of the entities could logically undertake. An effective tax planning strategy, using the entity variable, might be to shift deductions to ______ Corp and taxable income to ______ Corp. D; B Reason: The entity variable would suggest shifting deductions to the highest marginal tax rate entity (C) and income to the lowest (B). B; C Reason: The entity variable would suggest shifting deductions to the highest marginal tax rate entity (C) and income to the lowest (B). C; B Reason: The entity variable would suggest shifting deductions to the highest marginal tax rate entity (C) and income to the lowest (B). B; B Reason: The entity variable would suggest shifting deductions to the highest marginal tax rate entity (C) and income to the lowest (B).

C; B Reason: The entity variable would suggest shifting deductions to the highest marginal tax rate entity (C) and income to the lowest (B).

Bob is retired. He has very little income, but significant wealth. His son, Cody, is a successful CEO of a Fortune 100 company. They are jointly considering a significant donation to a qualified charity. Both are willing to make the donation which will result in a deduction. Who should make the donation to secure the best tax implication? Tax implication is the same for both Reason: The deduction is most valuable to the higher marginal tax rate taxpayer which is likely Cody. Cody Reason: The deduction is most valuable to the higher marginal tax rate taxpayer which is likely Cody. Bob Reason: The deduction is most valuable to the higher marginal tax rate taxpayer which is likely Cody.

Cody Reason: The deduction is most valuable to the higher marginal tax rate taxpayer which is likely Cody.

Crisco Company is contemplating a significant deductible expenditure. Which of the following structures for the expenditure is most effective in terms of the time period variable? Crisco will report the deduction in the current year and pay the cash in the following year. Crisco will pay the cash and report the deduction in the following year. Reason: The most effective strategy is to accelerate the deduction, while deferring payment of the cash. Crisco will pay the cash and report the deduction in the current year. Reason: The most effective strategy is to accelerate the deduction, while deferring payment of the cash. Crisco will pay the cash in the current year and report the deduction in the following year. Reason: The most effective strategy is to accelerate the deduction, while deferring payment of the cash.

Crisco will report the deduction in the current year and pay the cash in the following year.

Which of the following statements is true regarding income and deduction shifting? Deductions are most valuable when shifted to a higher taxed entity. Income is most valuable when shifted to a higher taxed entity. Reason: The tax cost decreases when shifted to a lower taxed entity. Income and deduction shifting is legal regardless of whether the transaction has economic substance. Reason: Income and deduction shifting is illegal if the transaction does not have economic substance.

Deductions are most valuable when shifted to a higher taxed entity.

Which of the following situations is least likely to result in increased marginal tax rate uncertainty for the taxpayer? Due to a natural disaster, Congress extended the filing deadline for all taxpayers in the affected area. The taxpayer was unemployed for six months after her company was sold and all employees terminated. Reason: The taxpayer's marginal tax rate is likely to be much lower than anticipated leading to marginal tax rate uncertainty. The taxpayer wins the lottery. Reason: The taxpayer's marginal tax rate is likely to be much higher than anticipated leading to marginal tax rate uncertainty.

Due to a natural disaster, Congress extended the filing deadline for all taxpayers in the affected area.

Ms. Paltrow structures a transaction to legally shift income from her sole proprietorship to her son's business. Which of the following terms best identifies the tax planning variable that she is likely utilizing? Character variable Entity variable Time period variable Jurisdiction variable

Entity variable

True or false: Opportunity cost refers to the increase in NPV resulting from a deferral of the receipt of before--tax cash flows. True Reason: Opportunity cost refers to the decrease in NPV resulting from a deferral of the receipt of before-tax cash flows. False

False

rue or false: The economic substance doctrine allows the IRS to collapse a series of intermediate transactions into a single transaction to determine the tax consequences of the arrangement in its entirety. True Reason: This statement reflects the step transaction doctrine. False Reason: This statement reflects the step transaction doctrine.

False Reason: This statement reflects the step transaction doctrine.

Which of the following statements is not accurate with respect to effective planning? Uncertain assumptions increase the risk that the actual outcome of a tax strategy may differ from projections. Flexible tax planning strategies should not be implemented because they cannot be relied on. Tax planning is based on assumptions about the future.

Flexible tax planning strategies should not be implemented because they cannot be relied on. Reason: Flexible tax strategies are desirable because they can be adapted to unforeseen circumstances.

Chad has engaged in a transaction that generated a $50,000 capital gain eligible for a 28% preferential tax rate. Which of the following statements is true? If Chad's marginal tax rate is 37%, the preferential rate saves Chad $4,500 in taxes. Reason: 9% tax savings × $50,000 = $4,500. If Chad's ordinary marginal tax rate is greater than 28%, the preferential rate has no value to him. Reason: To the extent that Chad's ordinary marginal tax rate is higher than the preferential rate, the preferential rate will save him taxes. If Chad's ordinary marginal tax rate is 12%, he may elect to recharacterize the gain as ordinary income. Reason: Taxpayers cannot elect to recharacterize income as ordinary or capital. The characterization is defined by statutory law.

If Chad's marginal tax rate is 37%, the preferential rate saves Chad $4,500 in taxes. Reason: 9% tax savings × $50,000 = $4,500.

Which of the following statements regarding the time period variable are false? (Select all that apply.) If Congress replaced the current tax structure with a proportionate rate structure, time period would no longer be relevant in tax planning. The time period variable becomes less important as the taxpayer's discount rate increases. Reason: Time value, and therefore the time period variable, becomes more important as the discount rate increases. Tax planning strategies based on the time period variable reflect the concept of time value of money. Tax planning strategies involving the time period variable must involve at least two tax years.

If Congress replaced the current tax structure with a proportionate rate structure, time period would no longer be relevant in tax planning. The time period variable becomes less important as the taxpayer's discount rate increases.

Ms. Bird has $10,000 to invest. She could buy corporate bonds with an 10% rate of return or municipal bonds with a 8% rate of return. Which of the following statements are true? (Select all that apply.) If Ms. Bird has a 24% marginal tax rate, she should invest in the tax-favored municipal bonds. Reason: After-tax return on municipal bonds is $800 (10,000 × 8%). After-tax return on corporate bonds is $760 calculated as $1000 annual return (10% × 10,000) subject to 24% (or $240) tax. After-tax return is $1000 - 240 = $760. If Ms. Bird invests in the corporate bonds, her implicit tax is $200. Reason: The corporate bonds are not tax-favored, therefore no implicit tax is paid. If Ms. Bird has a 12% marginal tax rate, she should invest in the tax-favored municipal bonds. Reason: After-tax return on municipal bonds is $800 (10,000 × 8%). After-tax return on corporate bonds is $850 calculated as $1000 annual return (10% × 10,000) subject to 12% (or $120) tax. After-tax return is $1000 - 120 = $880. If Ms. Bird invests in the municipal bonds, her implicit tax is $200. Reason: 10,000 × (10% - 8%) = $200.

If Ms. Bird has a 24% marginal tax rate, she should invest in the tax-favored municipal bonds. If Ms. Bird invests in the municipal bonds, her implicit tax is $200.

Atlas Corp. engaged in a transaction in the current year that generated $20,000 cash inflow. Which of the following statements is false? If the cash inflow is not taxable income, the current year tax cost is zero. If the cash inflow is taxable income and Atlas is subject to a 25% marginal tax rate, the current year tax cost is $5,000. Reason: $20,000 × 25% = $5,000. If the cash inflow is taxable income and Atlas is subject to a 10% tax rate, the after-tax cash inflow is $2,000.

If the cash inflow is taxable income and Atlas is subject to a 10% tax rate, the after-tax cash inflow is $2,000. Reason: Tax is computed as $20,000 × 10% = $2,000. After-tax cash flow is $20,000 - 2,000 = $18,000.

Which of the following statements is false regarding income and deduction shifting? Income and deduction shifting techniques result in lower tax revenues for the government. Income shifting is illegal regardless of whether the underlying transaction has a genuine business purpose. Reason: Income shifting is illegal when there is no genuine business purpose. The IRS more heavily scrutinizes related party transactions for income and deduction shifting practices. Reason: The IRS more heavily scrutinizes related party transactions because income shifting is more easily structured between related parties.

Income shifting is illegal regardless of whether the underlying transaction has a genuine business purpose. Reason: Income shifting is illegal when there is no genuine business purpose.

Which of the following factors could offset any benefit derived from deferring the taxability of a current cash inflow? (Select all that apply.) Decreases to the taxpayer's marginal tax rate Decreases to statutory tax rates Increases to statutory tax rates Increases to the taxpayer's marginal tax rate

Increases to statutory tax rates Increases to the taxpayer's marginal tax rate

Which of the following statements accurately describe taxable entities for U.S. federal income tax purposes? (Select all that apply.) Individuals conducting business as sole proprietors include the income generated by their business on their personal income tax return. A corporation is a tax paying entity. Thus, it computes and pays its own income taxes. All income generated by a partnership escapes U.S. taxation because a partnership is not a taxable entity. Reason: A partnership is not a taxable entity. The income generated by a partnership does not escape taxation. It is allocated to the partners who pay tax on the income.

Individuals conducting business as sole proprietors include the income generated by their business on their personal income tax return. A corporation is a tax paying entity. Thus, it computes and pays its own income taxes.

Which of the following strategies reflect tax planning using the character variable? (Select all that apply.) Engaging in a tax strategy that results in income shifted to a related entity Reason: This reflects tax strategies using the entity variable. Investing in municipal bonds Holding an investment for longer than one year, so the resulting gain will be taxed as capital gains rather than ordinary income Investing through a retirement account, so tax on earnings is deferred until funds are withdrawn Reason: This reflects the time period variable.

Investing in municipal bonds Holding an investment for longer than one year, so the resulting gain will be taxed as capital gains rather than ordinary income

The Clarks own a house that they rent for $1200 per month. They have instructed their tenant to write the monthly rental check to their daughter, Missy, who is a college student. She will use the money to pay her rent and monthly expenses. Which of the following statements is a correct application of the assignment of income doctrine? Missy must report the income on her tax return because she received the cash. Reason: Regardless of who the check is written to, for tax purposes the income belongs to the Clarks since their property was the source of the income It is not illegal for the tenants to write the check to Missy, but the income remains taxable to the Clarks. As long as the check is written directly to the Clarks' daughter, the rental income will not be taxed to the Clarks. Reason: Regardless of who the check is written to, for tax purposes the income belongs to the Clarks since their property was the source of the income.

It is not illegal for the tenants to write the check to Missy, but the income remains taxable to the Clarks.

Katie has started a new business and has been advised that she should not hire an employee but rather, should engage an independent contractor to perform the services that she needs. By doing so, she will minimize her payroll taxes. Which of the following statements is false? While she may minimize payroll taxes by hiring an independent contractor, non-tax costs may offset the benefit derived from avoiding payroll taxes. Katie should evaluate the net present value of the before tax cash flow to determine her best option. An independent contractor may require more remuneration to perform the services relative to an employee. This is an example of a non-tax cost.

Katie should evaluate the net present value of the before tax cash flow to determine her best option. Reason: Katie should evaluate the NPV of AFTER tax cash flow to determine her best option.

Which of the following statements about jurisdictions and the jurisdiction variable are true? (Select all that apply.) Most businesses are subject to taxation in more than one jurisdiction. Cash flows increase when transactions are structured such that deductions are concentrated in lower tax rate jurisdictions. Reason: Deductions are more valuable as the marginal tax rate increases. Businesses can often minimize total tax burden by conducting business in jurisdictions with favorable tax climates. For federal purposes, state income taxes are deductible in the computation of taxable income.

Most businesses are subject to taxation in more than one jurisdiction. Businesses can often minimize total tax burden by conducting business in jurisdictions with favorable tax climates. For federal purposes, state income taxes are deductible in the computation of taxable income.

Select the statement that best describes tax planning using the character variable? A typical example of using the character variable would involve converting capital gains to ordinary income to secure a preferential rate. Reason: A typical example would include converting ordinary income to capital gains. Congress has not been successful in passing legislation designed to protect the distinction between capital gains and ordinary income. Reason: Many provisions in the tax code are designed to protect the intended distinction between capital gains and ordinary income. Provisions in the Internal Revenue Code are designed to limit the "artificial" conversion of ordinary income to capital gains.

Provisions in the Internal Revenue Code are designed to limit the "artificial" conversion of ordinary income to capital gains.

marginal tax rate uncertainty

Reflects the possibility that a change to the taxpayer's financial situation may result in unanticipated changes to the marginal tax rate

audit risk

Reflects the possibility that the IRS may interpret or apply the law differently than the taxpayer

Which of the following are examples of transactional markets? (Select all that apply.) Related party Public Private Free Local

Related party Public Private

Riley received a $90,000 cash payment of which $40,000 was exempt from taxation. Riley's marginal tax rate is 30% and she has a 20% average tax rate. Which of the following statements is true?

Riley's tax cost is $15,000 and her after-tax cash flow is $75,000. Reason: Tax Cost: $50,000 taxable × 30% = $15,000 Note: Always use the marginal tax rate to evaluate. After-tax cash flow: $90,000 received - 15,000 tax = $75,000

Which of the following statements best describes "tax minimization"? Tax minimization with respect to a transaction may not always be the optimal strategy. Reason: The goal is to maximize the NPV of after-tax cash flows. Business actions that minimize taxes are always independent of the business's non-tax costs. Tax minimization should be the primary goal of business and financial planning. Reason: The goal is to maximize the NPV of after-tax cash flows. Tax minimization always maximizes the NPV. Reason: Tax minimization does not always maximize the NPV because, for example, it might constrain the ability to generate revenues or result in additional non-tax costs.

Tax minimization with respect to a transaction may not always be the optimal strategy. Reason: The goal is to maximize the NPV of after-tax cash flows.

Which of the following best describes tax planning opportunities? Tax planning opportunities are only afforded to the largest corporations or wealthiest individuals. Tax planning opportunities arise when the tax law applies differentially to business transactions. Tax planning opportunities are always a result of identifying vague or inconsistent provisions in the tax law.

Tax planning opportunities arise when the tax law applies differentially to business transactions.

Which of the following statements is false? All else equal, a tax rate increase results in higher tax costs and lower after-tax cash flows. The tax savings from a deductible expenditure increases as tax rates increase. Tax rates are constant across time and across transactions.

Tax rates are constant across time and across transactions. Reason: Tax rates can change across time and can vary across different types of transactions.

Which of the following reflect tax characterizations in the U.S. tax structure? (Select all that apply.) Capital gains arise from the sale of appreciated inventory. Reason: Capital gains arise from the sale of invested assets. Income generated from operating activities of a firm is termed "normal income". Reason: Operating income is generally termed "ordinary income". Tax-exempt municipal bond interest is interest from bonds issued from a local government. Income generated by a multinational firm can be described as "U.S.-sourced" or "foreign-sourced" income.

Tax-exempt municipal bond interest is interest from bonds issued from a local government. Income generated by a multinational firm can be described as "U.S.-sourced" or "foreign-sourced" income.

Which of the following statements about a related party transaction is false? The transaction may lack the economic tension characteristic of a transaction between unrelated parties. The IRS may disallow favorable tax outcomes if it is determined the parties transacted at arm's length. The transaction may reflect a fictitious market. The parties to the transaction may have compatible financial objectives.

The IRS may disallow favorable tax outcomes if it is determined the parties transacted at arm's length. Reason: The IRS may disallow favorable tax outcomes if it is determined that the parties did not transact at arm's length.

Acme Corporation engaged in a transaction that required a $20,000 expenditure. The expenditure was 50% deductible and Acme is subject to a 20% marginal tax rate. Which of the following statements are true? (Select all that apply.) The after-tax cash outflow associated with the expenditure is $18,000. Reason: - $20,000 before tax cash outflow + $2,000 tax savings = - $18,000 net cash outflow. The after-tax cash outflow associated with the expenditure is $22,000. Reason: - $20,000 before tax cash outflow + $2,000 tax savings = - $18,000 net cash outflow. The tax savings associated with the expenditure is $4,000. Reason: $10,000 is deductible × 20% tax rate = $2,000 tax savings. The tax savings associated with the expenditure is $2,000. Reason: $10,000 is deductible × 20% tax rate = $2,000 tax savings.

The after-tax cash outflow associated with the expenditure is $18,000. Reason: - $20,000 before tax cash outflow + $2,000 tax savings = - $18,000 net cash outflow. The tax savings associated with the expenditure is $2,000. Reason: $10,000 is deductible × 20% tax rate = $2,000 tax savings.

Assume that Congress is considering several new tax provisions to encourage savings. Each of the proposed structures allows an individual to invest up to $18,000 of annual earnings in a savings plan which allows no current deduction. Which structure employs the time period variable to provide a tax incentive to save? The earnings invested and the income generated from that investment will be taxed when earned at a lower, preferential rate. Reason: This structure uses the character variable rather than the time period variable. The annual earnings invested and income generated from that investment will not be taxed until the funds are withdrawn upon retirement. The savings plan allows for investment in government funds that guarantee a minimum return which increases the longer the funds are invested.

The annual earnings invested and income generated from that investment will not be taxed until the funds are withdrawn upon retirement.

Josh has the opportunity to engage in a transaction that provides an immediate cash inflow, but defers the tax on that cash for several years. Which of the following statements best reflects the uncertainty inherent in this transaction? The benefit of deferral of the tax may be offset by unanticipated decreases in statutory tax rates. Reason: The benefit of deferral of the tax may be offset by unanticipated increases in statutory tax rates. The risk of unanticipated tax rate changes generally decreases as the length of deferral increases. Reason: The longer the deferral period, the more likely that statutory rates may change. The benefit of deferral of the tax may be offset by unanticipated increases in statutory tax rates.

The benefit of deferral of the tax may be offset by unanticipated increases in statutory tax rates.

Which of the following statements regarding the U.S. federal income tax structures are correct? (Select all that apply.) The individual income tax structure is regressive. Reason: The individual income tax structure is progressive. The corporate income tax structure is proportionate. The individual income tax structure has multiple tax brackets. The individual income tax structure is progressive. The corporate income tax structure is progressive. Reason: Following the Tax Cuts and Jobs Act, the corporate income tax is computed at a flat rate of 21 percent.

The corporate income tax structure is proportionate. The individual income tax structure has multiple tax brackets. The individual income tax structure is progressive.

Which of the following statements about tax planning is false? The difference between tax avoidance and tax evasion is clearly defined in the tax law. Tax avoidance is legal. Sound tax planning should involve tax strategies that are entirely legal.

The difference between tax avoidance and tax evasion is clearly defined in the tax law. Reason: Because the tax law cannot be written to address every possible circumstance, ambiguities exist and it is not always clear whether an action constitutes avoidance or evasion.

Which of the following statements regarding effective tax planning using the entity variable is false? Tax costs decrease and cash flow increases when taxable income is shifted to the low marginal tax rate entity. The entity variable refers only to planning between two different entity types (corporation versus individual) and not between two of the same type. The after-tax value of a dollar of income generated in a low tax entity is greater than the same income generated in a high tax entity.

The entity variable refers only to planning between two different entity types (corporation versus individual) and not between two of the same type. Reason: The entity variable refers to shifting both between entity types and between two entities of the same type, but with different marginal tax rates.

Which of the following statements about tax deferral is false? (Select all that apply.) The value of a tax deferral increases as the taxpayer's discount rate increases. The greater the length of time that the payment of a tax is deferred, the greater the tax cost in NPV terms. Tax deferral is never an effective planning strategy if the taxpayer's marginal tax rate does not change over time. Tax deferral is a key planning strategy using the time period variable.

The greater the length of time that the payment of a tax is deferred, the greater the tax cost in NPV terms. Tax deferral is never an effective planning strategy if the taxpayer's marginal tax rate does not change over time.

Which of the following statements best describes the estimation of a discount rate for analyzing a transaction? The higher the marginal tax rate, the higher the discount rate. Reason: The discount rate is independent of marginal tax rate, length of time period, or amount of cash flow. The longer the period in which the transaction will generate cash flows, the greater the discount rate. Reason: The discount rate is independent of marginal tax rate, length of time period, or amount of cash flow. The greater the cash flow, the higher the discount rate. Reason: The discount rate is independent of marginal tax rate, length of time period, or amount of cash flow. The higher the risk involved in a transaction, the higher the discount rate.

The higher the risk involved in a transaction, the higher the discount rate.

Farm Depot has the opportunity to engage in a transaction that will generate $100,000 cash in the current year. The transaction will be structured such that provisions of the tax law allow them to defer tax on the income by recognizing $25,000 taxable income each year for the next four years. Based on NPV projections, Farm Depot decides to pursue the opportunity. Which of the following statements are true? (Select all that apply.) The proposed structure reflects the time period variable. The IRS may challenge the tax deferral if the proposed structure does not have a genuine business purpose. All else equal, the proposed structure will result in a lower NPV than projected if tax rates increase over the next four years. Once Farm Depot engages in the transaction, changes in tax rates will not cause actual results to vary from NPV projections. Reason: NPV projections are based on assumptions about tax rates. Changes in future tax rates are a source of uncertainty that can lead to significantly different outcomes.

The proposed structure reflects the time period variable. The IRS may challenge the tax deferral if the proposed structure does not have a genuine business purpose. All else equal, the proposed structure will result in a lower NPV than projected if tax rates increase over the next four years.

implicit tax

The reduction in the before-tax rate of return on a tax-favored asset =could have earned - earned

Which of the following statements about the character variable is true? Parameters that determine tax character and the resulting tax treatment are static and cannot change from year to year. Reason: Congress can and often does change tax legislation that affects characterization of income or the resulting tax treatment. The tax character of income is determined strictly by tax law. Tax planning strategies using the character variable are based on transactions between two unrelated parties

The tax character of income is determined strictly by tax law.

Your Answer incorrect Which statement is false regarding transactional markets? The ability to structure a transaction for a better tax result is dependent on the flexibility of the market in which the transaction is occurring. A market is a forum for commercial interaction between two parties for the purpose of transacting. The type of transactional market (public, private, etc.) has little impact on the degree of control a manager has to structure a transaction.

The type of transactional market (public, private, etc.) has little impact on the degree of control a manager has to structure a transaction.

True or false: The ability to defer payment of a tax to a later time period increases the net present value of the after-tax cash flow of the transaction. However, this financial benefit may be mitigated if Congress increases tax rates over that same time period. True False Reason: In general, deferring the payment of tax increases the NPV of the transaction. However, this benefit may be offset by any tax increase that occurs during that same period.

True

Which of the following statements reflect the primary source of marginal tax rate uncertainty? (Select two answers.) Unanticipated changes to a taxpayer's taxable income Unanticipated changes to the tax rate structure Unanticipated changes in the filing deadlines and late filing penalties Differences between the taxpayer and IRS interpretation of the law Reason: This reflects audit risk.

Unanticipated changes to a taxpayer's taxable income Unanticipated changes to the tax rate structure

A decrease in risk associated with a future stream of cash should result in ______ in the discount rate resulting in ______ in the net present value. an increase, a decrease an increase, an increase a decrease, an increase no change, no change a decrease, a decrease

a decrease, an increase

The tax law contains a provision that excludes from taxation up to $250,000 of gain (for a single taxpayer) on the sale of the personal residence. Among other things, the law requires that the home serve as the personal residence of the taxpayer for a specific period of time prior to the sale. If John delayed the sale of his home to meet this requirement, it may be an example of tax planning using the ______. jurisdiction variable Reason: John is converting taxable income to tax-exempt income. time period variable Reason: John is converting taxable income to tax-exempt income. character variable entity variable Reason: John is converting taxable income to tax-exempt income.

character variable

The assignment of income doctrine holds that income from a transaction must be taxed to the person who ______. reports the transaction on his or her tax return Reason: The doctrine holds that the income from the transaction must be taxed to the person who earns the income. receives the cash from the transaction Reason: The doctrine holds that the income from the transaction must be taxed to the person who earns the income. earns the income

earns the income

Mr. Johns transfers 100 shares of Acorn stock to his 16-year old son. The stock pays a semi-annual dividend. This strategy may be an example of tax planning using the ______. jurisdiction variable Reason: The dividend income (and asset) is being transferred from one entity (the parent) to a lower taxed entity (the son). This is an example of the entity variable. entity variable time period variable Reason: The dividend income (and asset) is being transferred from one entity (the parent) to a lower taxed entity (the son). This is an example of the entity variable. character variable Reason: The dividend income (and asset) is being transferred from one entity (the parent) to a lower taxed entity (the son). This is an example of the entity variable.

entity variable

Hillmer Corporation structures a transaction to shift income from its New York City office to its Dallas office. This tax planning strategy may be taking advantage of the ______. time period variable character variable jurisdiction variable entity variable

jurisdiction variable

In public market transactions, the parties ______. are not transacting at arm's length must engage in unilateral, rather than bilateral, tax planning most commonly negotiate directly with each other

must engage in unilateral, rather than bilateral, tax planning

A private letter ruling is ______. (Select all that apply.) often requested by a taxpayer to reduce audit risk an agreement that the IRS will not challenge the taxpayer if the tax consequences of the transaction are reported as identified in the PLR a free service provided by the federal government Reason: A PLR can be costly. anonymous. The taxpayer requesting the ruling only discloses the details of the transaction and not its identity to the IRS Reason: A PLR is not anonymous. The taxpayer discloses both identity and details of the transaction.

often requested by a taxpayer to reduce audit risk an agreement that the IRS will not challenge the taxpayer if the tax consequences of the transaction are reported as identified in the PLR

When the IRS audits a tax return, it is most likely to scrutinize the tax consequences of a(n) ______. related party transaction arm's length transaction private market transaction. public market transaction

related party transaction

Municipal bond interest tax treatment

tax exempt

In December 2014, Congress passed legislation that was retroactively applied to the entire year. This legislation increased ______. audit risk uncertainty tax law uncertainty marginal tax rate uncertainty

tax law uncertainty

In anticipation of a new 3.8% Medicare tax on investment income, Katie has decided to liquidate several of her investments before the effective date. This strategy may be an example of tax planning using the ______. entity variable character variable time period variable jurisdiction variable

time period variable