Ac 402 questions I dont know

If John invested $20,000 in a stock paying annual qualifying dividends (0% tax rate) equal to 4% of his investment, what would the value of his investment be 5 years from now? Assuming dividends were reinvested each year and his marginal ordinary tax rate is 15%. (Do not round intermediate calculations.)

$24,333 ATRR = 0.04 (0.04 × (1 − 0)); $20,000 × (1.04)^5 = $24,333.

If Rachel has a 37% tax rate and a 10% after-tax rate of return, a $100,000 tax deduction in one year will save how much tax in today's dollars (rounded)? (Exhibit 3-1)

$33,633 $100,000 × 0.37 (tax rate) × 0.909 (Discount Factor, 10%, 1 year) = $33,633.

If Jack earns an 8% after-tax rate of return, $10,000 received in three years is worth how much today (rounded)? (Exhibit 3-1)

$7,940 $10,000 × 0.794 (Discount Factor, 3 years, 8%) = $7,940.

Substance-over-form doctrine:

-IRS can reclassify a transaction according to its substance (instead of its form).

•Economic substance doctrine:

-Transactions must meet two criteria 1.Transaction must meaningfully change a taxpayer's economic position (excluding any federal income tax effects). 2.Taxpayer must have a substantial purpose (other than tax avoidance) for the transaction.

What explicit tax rate would keep Orlando indifferent between purchasing a municipal bond with a 4.0 percent return and a taxable bond with a 5.5 percent before-tax return?

27.3% 0.055 × (1 − tax rate) = 0.04; tax rate = 27.3 percent.

Constructive receipt doctrine:

taxpayer must recognize income when it is actually or constructively received.

Assume that Bill's marginal tax rate is 37%. If corporate bonds pay 10% interest, what interest rate would a municipal bond have to offer for Bill to be indifferent between the two bonds?

6.30% 10% × (1 − 0.37) = 6.30%

Which of the following is an example of the conversion strategy?

An employer providing tax free benefits to employees instead of salary. A common conversion strategy is for employers to pay employees with tax-free employee benefits instead of taxable salary, thus converting taxable compensation to nontaxable compensation.

Which of the following strategies exploits the fact that tax rates vary by activity (e.g., income type)?

Conversion: The conversion strategy is based on fact that different activities are subject to different tax rates. For example, ordinary income such as salary, interest income, and business income received by individual taxpayers is taxed at their ordinary marginal tax rates, whereas long-term capital gains, which are gains from the sale of investment assets held longer than one year, and dividends are taxed at lower tax rates (currently a maximum of 20 percent), and still other forms of income like nontaxable compensation benefits and municipal bond interest are tax-exempt.

An investment's time horizon affects the after-tax rate of return on investments taxed annually.

False

The conversion strategy becomes more important as interest rates increase.

False

Step-transaction doctrine:

IRS has the power to collapse a series of transactions into one to determine tax liability

Business purpose doctrine

IRS has the power to disallow business expenses for transactions that don't have a business purpose.

The assignment of income doctrine most likely limits which of the following strategies?

Income shifting The assignment of income doctrine requires income to be taxed to the taxpayer who actually earns it and most often limits the income shifting strategy.

Present Value Formula

Present Value = Future Value/(1 + r)^n

A common income shifting strategy is to:

Shift income from a high tax rate jurisdiction to a low tax rate jurisdiction. Income shifting attempts to shift income from high tax rate to low tax rate taxpayers or jurisdictions and deductions from low tax rate to high tax rate taxpayers or jurisdictions.

Geraldo recently won a lottery and chose to receive $100,000 today instead of an equivalent amount in 10 years, computed using an 8 percent rate of return. Today, he learned that interest rates are expected to increase in the future. Use Exhibit 3.1. Is this good news for Geraldo given his decision?

This is good news for Geraldo's decision. If Geraldo chose to defer the $100,000 at an 8 percent interest rate, the increase in interest rates would have reduced the present value of the lottery winnings. The equivalent amount in 10 years at 8 percent is approximately $216,000. If this amount was discounted back to present value at 10 percent (instead of 8 percent), the present value would be only about $83,000.

If tax rates will be the same next year, the taxpayer should generally accelerate deductions.

True

The income shifting strategy exploits the fact that tax rates vary across taxpayers or jurisdictions.

True

The present value concept becomes more important as interest rates increase.

True

The timing strategy is based on the idea that the period in which income is taxed affects the tax costs of the income

True

IRS audit selection processes & common computer initiatives

a. DIF system: this system assigns a score representing probability the return is underreported based on historical data from the National Research Program b. Document Perfection program: how "perfect" is the return? Checked for mathematical and calculation errors c. Information matching: 'information' from the taxpayer is "matched" to information from others (info such as wages, interest, dividends from others such as employers, banks, mortgage Company, mutual funds etc.)

Tax Return Extension

a. Not an extension to "pay" taxes - just extension to file return b. 6 month extension for individuals - generally October 15 c. 5-6-7 month extension for corporations

Isabel, a calendar-year taxpayer, uses the cash method of accounting for her sole proprietorship. In late December she received a $20,000 bill from her accountant for consulting services related to her small business. Isabel can pay the $20,000 bill anytime before January 30 of next year without penalty. Assume her marginal tax rate is 37 percent this year and next year, and that she can earn an after-tax rate of return of 12 percent on her investments. a. What is the after-tax cost if Isabel pays the $20,000 bill in December? b. What is the after-tax cost if Isabel pays the $20,000 bill in January? Use Exhibit 3.1. (Round your answer to the nearest whole dollar amount.) c.Based on requirements a and b, should Isabel pay the $20,000 bill in December or January?

a. Pay $20,000 bill in December: $20,000 tax deduction × 37 percent marginal tax rate = $7,400 in present value tax savings. After-tax cost = Pretax cost − Present value tax savings = $20,000 − $7,400 = $12,600 b. Pay $20,000 bill in January: $20,000 tax deduction × 37 percent marginal tax rate = $7,400 in tax savings in one year. Present value of tax savings = $7,400 × 0.893 (Discount factor, 1 Year, 12 percent) = $6,608 After-tax cost = Pretax cost − Present value tax savings = $20,000 − $6,608 = $13,392 c. Paying the $20,000 in December is the clear winner. Accelerating her payment from January to December will increase the present value of the cash outflow by a few days. Thus, there is a minor present value cost associated with accelerating her payment.

Hank, a calendar-year taxpayer, uses the cash method of accounting for his sole proprietorship. In late December, he performed $20,000 of legal services for a client. Hank typically requires his clients to pay his bills immediately upon receipt. Assume his marginal tax rate is 32 percent this year and will be 35 percent next year, and that he can earn an after-tax rate of return of 12 percent on his investments. Use Exhibit 3.1. a. What is the after-tax income if Hank sends his client the bill in December? b. What is the after-tax income if Hank sends his client the bill in January? c. Should Hank send his client the bill in December or January? d. What is the after-tax income if Hank expects his marginal tax rate to be 24 percent next year and sends his client the bill in January? (Round your answer to the nearest whole dollar amount.) e. Should Hank send his client the bill in December or January if he expects his marginal tax rate to be 32 percent this year and 24 percent next year?

a. Send the $20,000 bill in December: $20,000 taxable income × 32 percent marginal tax rate = $6,400 in present value tax After-tax income = Pretax income − Present value tax = $20,000 − $6,400 = $13,600 b. Send the $20,000 bill in January: If the tax rate next year is 35 percent $20,000 taxable income × 35 percent marginal tax rate = $7,000 in tax in one year. Present value of tax = $7,000 × 0.893 (Discount factor, 1 Year, 12 percent) = $6,251 After-tax income = Pretax income − Present value tax = $20,000 − $6,251 = $13,749 c. Sending the $20,000 bill in January would be preferred. Delaying the invoice to January will decrease the present value of the cash inflow by a few days. Thus, there is a minor present value cost associated with delaying the income. d. Send the $20,000 bill in January: If the tax rate next year is 24 percent instead of 35 percent. $20,000 taxable income × 24 percent marginal tax rate = $4,800 in tax in one year. Present value of tax = $4,800 × 0.893 (Discount factor, 1 Year, 12 percent) = $4,286 After-tax income = Pretax income − Present value tax = $20,000 − $4,286 = $15,714 e. Sending the $20,000 bill in January would be preferred. Delaying the invoice to January will decrease the present value of the cash inflow by a few days. Thus, there is a minor present value cost associated with delaying the income.

•Statute of limitations:

the time in which the taxpayer can file an amended return or the IRS can assess a tax deficiency. -Generally ends three years from the later of (1) the date the tax return was actually filed or (2) the tax return's original due date. a. Never filing a tax return no statute of limitations b. None for fraud c. 6 years for omitting >25% of gross income on return §650(e)(1)

Tax Return Due dates

•Individuals: fifteenth day of fourth month following end of tax year. •C corporations: generally fifteenth day of the fourth month following end of tax year. •Partnerships and S corporations: fifteenth day of third month following end of tax year. •Due dates on a Saturday, Sunday, or holiday are extended to the next business day. •Individuals, corporations, and partnerships are allowed to apply for automatic extensions.