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Exam 3: Tax Planning Strategies and Related Limitations

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Question 21

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Based only on the information provided for each scenario, determine whether Kristi or Cindy will benefit more from using the timing strategy and why there will be a benefit to that person. Use Exhibit 3.1. (Round discount factor(s) to 3 decimal places.) a. Kristi has a 40% tax rate and can defer $20,000 of income. Cindy has a 30% tax rate and can defer $30,000 of income. b. Kristy has a 30% tax rate, a 10% after-tax rate of return, and can defer $25,000 of income for three years. Cindy has a 40% tax rate, an 8% after-tax rate of return, and can defer $20,000 of income for four years.

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(a) Cindy, because she can defer $9,000 ...

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Question 22

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Joe Harry, a cash basis taxpayer, owes $20,000 in tax deductible accounting fees for his business. Assume that it is December 28^th and that Joe Harry can avoid any finance charges if he pays the accounting fees by January 10^th. Joe Harry's tax rate this year is 30%. His tax rate next year will be 33%. His after-tax rate of return is 8%. When should Joe Harry pay the $20,000 fees and why? Use Exhibit 3.1. (Round discount factor(s) to 3 decimal places.)

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If Joe Harry pays the $20,000 in Decembe...

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Question 23

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Paying dividends to shareholders is one effective way of shifting income from a corporation to its shareholders.

When considering cash inflows, higher present values are preferred.

Assume that Will's marginal tax rate is 32% and his tax rate on dividends is 15%. If a dividend-paying stock (with no growth potential) pays a dividend yield of 8%, what interest rate must the corporate bond offer for Will to be indifferent between the two investments from a cash-flow perspective?

Which of the following increases the benefits of income deferral?

Maurice is currently considering investing in a high dividend yield stock with no growth potential that pays a 6% dividend yield or bonds issued by The Coca Cola Company that pay 8%. If Maurice's ordinary tax rate is 25% and his dividend tax rate is 15%, which investment should he choose? Which investment should he choose if his ordinary tax rate is 30%? At what ordinary tax rate would he be indifferent to the stock or to the bond? What strategy is this decision based upon?

Assume that Bill's marginal tax rate is 30%. If corporate bonds pay 8% interest, what interest rate would a municipal bond have to offer for Bill to be indifferent between the two bonds?

Assume that Shavonne's marginal tax rate is 50% and her tax rate on dividends is 15%. If a corporate bond pays 10.20% interest, what dividend yield would a dividend-paying stock (with no growth potential) have to offer for Shavonne to be indifferent between the two investments from a cash-flow perspective?

An investment's time horizon does not affect after-tax rates of return on investments taxed annually.

If Thomas has a 40% tax rate and a 6% after-tax rate of return, $50,000 of income in five years will cost him how much tax in today's dollars? Use Exhibit 3.1. (Round present and future value amounts to 3 places)

Assume that Larry's marginal tax rate is 25%. If corporate bonds pay 10% interest, what interest rate would a municipal bond have to offer for Larry to be indifferent between the two bonds?

A taxpayer earning income in "cash" and not reporting it as taxable income is an example of:

Which of the following does not limit the income shifting strategy?

Rodney, a cash basis taxpayer, owes $40,000 in tax deductible consulting fees for his business. Assume that it is December 28^th and that Rodney can avoid any finance charges if he pays the accounting fees by January 10^th. Rodney's tax rate this year is 30% and his after-tax rate of return is 10%. At what tax rate next year, will Rodney be indifferent between paying the $40,000 this year and next year? Use Exhibit 3.1. (Round discount factor(s) to 3 decimal places.)

The timing strategy is particularly effective for cash basis taxpayers.

In general, tax planners prefer to accelerate deductions.

O'Reilly is a masterful lottery player. The megamillion jackpot is now up to $200 million. If O'Reilly wins the jackpot, he has a choice of receiving $200 million in 5 years or a smaller lump sum currently. Advise O'Reilly on his choice under the following scenarios. Which option should he take and why? Use Exhibit 3.1. a. O'Reilly's after-tax return is 10%. If he chooses the current lump sum option, the lottery will pay him $130 million. b. O'Reilly's after-tax return is 10%. His current tax rate will be 35% if he receives the lottery payment now. His expected tax rate in five years will be 40%. If he chooses the current lump sum option, the lottery will pay him $100 million.

Explain why $1 today is not equal to $1 in the future. Why is understanding this concept particularly important for tax planning? What tax strategy exploits this concept?

Effective tax planning requires all of these considerations except: