Federal Income Tax Ch3

Which of the following doctrines is NOT used by the IRS to examine transactions where it expects taxpayer abuse?

tax minimization doctrine

Which of the following choices is an advantage of shifting income across jurisdictions?

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

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

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

timing, conversion

Which of the following transactions would NOT be acceptable to the IRS as a means of switching the taxable income to another taxpayer?

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

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 6% interest rate (after tax) she will have $_______ one year from now.

5,300 (amount + 6%)

Which of the following terms is NOT one of the three basic tax planning strategies?

Tax minimixation

Which of the following statements is INCORRECT regarding tax planning?

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

Which of the following statements are CORRECT?

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

Which of the following statements is INCORRECT regarding income shifting strategies across 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.

The taxpayers who are MOST likely to benefit from an income shifting strategy include which of the following choices?

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

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

accelerate, defer

When tax rates are decreasing, taxpayers should __________ tax deductions and _________ taxable income.

accelerate, defer

Timing

accelerating tax deductions and deferring the recognition of taxable income

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

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%?

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

Under what circumstances might a taxpayer want to defer the recognition of income?

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

Under which of the following situations is a strategy for the timing of deductions most beneficial?

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

Which of the following statements is correct regarding present value?

a $1 today is worth more than $1 in the future

Which of the following methods will NOT result in a tax beneficial shift of income from a corporation to its employee-owner?

paying dividends to the employee-owner

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.

Blank 1: higher Blank 2: lower

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

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

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.

present value

Which of the following is NOT necessarily a part of effective tax planning?

Minimizing tax payments

True or false: Neither tax avoidance nor tax evasion is acceptable or legal in the U.S.

false

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

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

low, high

Select the two most important considerations that are necessary for effective tax planning for individuals.

maximizing after-tax wealth achieving non-tax related goals

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

more

Income Shifting

moving income and deductions from taxpayers in one tax bracket to taxpayers in a different tax bracket

Which of the following are tax planning methods used in income shifting strategies?

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?

moving income to more tax favorable jurisdictions

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?

$523.60 ($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

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.

0.943 (1/(1+6%) (year/(year+%))

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 $__________.

2,400; (3000-20%) 2,299 (

Which of the following taxpayers would likely benefit LEAST from an income shifting strategy?

A taxpayer with a business that operates in one state

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.

When considering the timing of transactions, what tax planning strategy should be used for tax deductions if tax rates are constant?

Because tax deductions result in tax payments, they should be deducted in an earlier period (accelerated) when possible.

Andre has the option of receiving $1,800 today or $1,860 a year from now. Assuming Andre can invest the money and earn 4 percent this year, he would have $_________ a year from now. He should take the $____________. (1,800/1,860).

Blank 1: 1,872 (1800 x .04) or (1800+4%) Blank 2: 1,800

Tax ___ is the legal act of arranging one's transactions to minimize taxes paid. Tax ___ is the willful act of defrauding the government by NOT paying taxes legally owed.

Blank 1: avoidance Blank 2: evasion

Match the judicial doctrine used by the IRS when taxpayer abuse is suspected with the description of the doctrine.

Business purpose doctrine-Allows the IRS to challenge and disallow business expenses with no underlying business motivation Step-transaction doctrine-Allows the IRS to collapse a series of related transactions into one transaction to determine the tax consequences Substance over form doctrine-Allows the IRS to consider the purpose of the transaction regardless of the way it is structured Economic substance doctrine-Requires the transaction to meet two criteria: (1) meaningfully change a taxpayer's economic position and (2) have a substantial purpose for the transaction

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.

Corporate stock-$212.50 (most favorable) Corporate bonds-$201.00 Tax-exempt securities-$200.00

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.

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

False

Neither tax avoidance nor tax evasion is acceptable or legal in the U.S.

False

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

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 options are limitations of a timing strategy?

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 options best describes the basis for conversion strategies?

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

Which of the following taxpayers is using an income shifting tax planning strategy?

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.

Conversion

changing the type of income to a more tax-favored form of income

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

constructive receipt

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

conversion

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 tax planning strategies is based on the understanding that the tax law does NOT treat all types of income and deductions the same?

conversion strategy

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

decreasing

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.

deduction, income

All other things being equal, taxpayers should prefer to recognize _________ during high-tax rate years and ________ during low-tax rate years.

deductions, income

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

defer

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

deferring

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

derferring