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Exam 3: Tax Planning Strategies and Related Limitations

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Question 21

True/False

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Assuming an after-tax rate of return of 10%, John should prefer to pay an expense of $85 today instead of an expense of $100 in one year. Use Exhibit 3.1.

A) True
B) False

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Question 22

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Assume that John's marginal tax rate is 40%. If a city of Austin bond pays 6% interest, what interest rate would a corporate bond have to offer for John to be indifferent between the two bonds?

A) 6.00%.
B) 10.00%.
C) 3.60%.
D) 30.00%.
E) None of the choices are correct.

F) B) and D)
G) B) and C)

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Question 23

Multiple Choice

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Assume that Javier is indifferent between investing in a city of El Paso bond that pays5% interest and a corporate bond that pays 6.25% interest. What is Javier's marginal tax rate?

Assume that Juanita is indifferent between investing in a corporate bond that pays 10.2% interest and a stock with no growth potential that pays a 6% dividend yield. Assume that the tax rate on dividends is 15%. What is Juanita's marginal tax rate?

Luther was very excited to hear about the potential tax savings from shifting income from hiscorporation to him. The next day he had his corporation declare a $30,000 dividend to him. Is this an effective income shifting strategy? If so, why? If not, why not? What recommendations do you have for Luther?

Assume that Keisha's marginal tax rate is 40% and her tax rate on dividends is 15%. If a city of Atlanta bond pays 7.65% interest, what dividend yield would a dividend-paying stock (with no growth potential) have to offer for Keisha to be indifferent between the two investments from a cash-flow perspective?

Antonella works for a company that pays a year-end bonus in December of each year. Assume that Antonella expects to receive a $20,000 bonus in December this year, her tax rate is 30%, and her after-tax rate of return is 8%. If Antonella's employer paid her bonus on January 1 of next yearinstead of in December, how much would this action save Antonella in today's tax dollars? If Antonella's tax rate increased to 32% next year, would receiving the bonus in January still be advantageous? Use Exhibit 3.1.

Which of the following increases the benefits of income deferral?

A taxpayer paying his 10-year-old daughter $50,000 a year for consulting likely violates which doctrine?

Rob is currently considering investing in municipal bonds that earn 4% interest or taxable bonds issued by Dell Computer that pay 6.5%. If Rob's tax rate is 20%, which bond should he choose? Which bond should he choose if his tax rate is 30%? At what tax rate would he be indifferent to the municipal bond or to the corporate bond? What strategy is this decision based upon?

Future value can be computed as Future Value = Present Value/(1 + r)n.

David, an attorney and cash basis taxpayer, is new to the concept of tax planning and recentlylearned of the timing strategy. To implement the timing strategy, David plans to establish a new policy that allows his clients to wait up to five years to pay their attorney fees. Assume that David expects his marginal tax rates to remain constant over the foreseeable future. What is wrong with this strategy?

Which of the following is needed to implement the income shifting strategy?

The assignment of income doctrine is a natural limitation to the timing strategy.

The business purpose, step-transaction, and substance-over-form doctrines may limit the conversion strategy.

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

Assume that Marsha is indifferent between investing in a city of Destin bond that pays6% interest and a corporate bond that pays 8% interest. What is Marsha's marginal tax rate?

Susan Brown has decided that she would like to go back to school after her kids leave home in five years. To save for her education, Susan would like to invest $25,000 in an investment that provides a high return. If her marginal tax rate is 35 percent, what is Susan's after-tax rate of return for the following investment options? Qualified dividends are taxed at 15 percent. (Round your interim calculations to the nearest whole number)(1) Corporate bond issued at face value with 10 percent stated interest rate payable annually. (2) Dividend-paying stock with an annual qualifying dividend equal to 10% of her investment. (3) Growth stock with an annual growth rate of 8 percent and no dividends paid.

The timing strategy becomes more attractive if a taxpayer is able to accelerate deductions by two or more years (versus one year).

Bono owns and operates a sole proprietorship and has a 30% marginal tax rate. He provides his son, Richie, $12,000 a year for college expenses. Richie works as a street musician and has a marginaltax rate of 15%. What could Bono do to reduce his family tax burden? How much pre-tax income does it currently take Bono to generate the $12,000 after-taxes given to Richie? If Richie worked for his father's sole proprietorship, what salary would Bono have to pay him to generate $12,000 after taxes? (Ignore any Social Security, Medicare, or Self Employment Tax issues.) How much money would this strategy save?