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Exam 3: Tax Planning Strategies and Related Limitations

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Question 21

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If tax rates will be higher next year, taxpayers should accelerate their deductions regardless of their after-tax rate of return.

A) True
B) False

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Question 22

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If Rudy has a 25 percent tax rate and a 6 percent after-tax rate of return, a $30,000 tax deduction in four years will save how much tax in today's dollars? Use Exhibit 3.1. (Round discount factor(s) to three decimal places.)

A) $30,000
B) $7,500
C) $23,760
D) $5,940
E) None of the choices are correct.

F) A) and B)
G) B) and E)

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Question 23

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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 five years or a smaller lump sum now. 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 percent. If he chooses the current lump-sum option, the lottery will pay him $130 million. b. O'Reilly's after-tax return is 10 percent. His current tax rate will be 35 percent if he receives the lottery payment now. His expected tax rate in five years will be 40 percent. If he chooses the current lump-sum option, the lottery will pay him $100 million.

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

Assume that Will's marginal tax rate is 35 percent and his tax rate on dividends is 15 percent. If a dividend-paying stock (with no growth potential) pays a dividend yield of 7 percent, what interest rate must the corporate bond offer for Will to be indifferent between the two investments from a cash-flow perspective?

In general, tax planners prefer to accelerate deductions.

When considering cash outflows, higher present values are preferred.

Sal, a calendar-year taxpayer, uses the cash-basis method of accounting for his sole proprietorship. In late December, he performed $40,000 of consulting services for a client. Sal typically requires his clients to pay his bills immediately upon receipt. Assume that Sal's marginal tax rate is 32 percent this year and 37 percent next year and that he can earn an after-tax rate of return of 12 percent on his investments. Should Sal send his client the bill in December or January? Use Exhibit 3.1. (Round discount factor(s)to three decimal places.)

Assume that Lucas's marginal tax rate is 22 percent and his tax rate on dividends is 11 percent. If a dividend-paying stock (with no growth potential) pays an 9 percent dividend yield, what interest rate would a municipal bond have to offer for Lucas to be indifferent between the two investments from a cash-flow perspective?

Assume that Will's marginal tax rate is 32 percent and his tax rate on dividends is 15 percent. If a dividend-paying stock (with no growth potential) pays a dividend yield of 8 percent, 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 is an example of the income-shifting strategy?

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. (1)Corporate bond issued at face value with 15 percent stated interest rate payable annually. (2)Dividend-paying stock with an annual qualifying dividend equal to 8 percent of her investment. (3)Growth stock with an annual growth rate of 8.2 percent and no dividends paid. (Round your intermediate calculations to the nearest whole number.)

Assume that Juanita is indifferent between investing in a corporate bond that pays 10.20 percent interest and a stock with no growth potential that pays a 6 percent dividend yield. Assume that the tax rate on dividends is 15 percent. What is Juanita's marginal tax rate?

Jayzee is a single taxpayer who operates a sole proprietorship. He expects his taxable income next year to be $150,000, of which $125,000 is attributed to his sole proprietorship. Jayzee is contemplating incorporating his sole proprietorship. Using the 2020 single individual tax brackets and the corporate tax brackets, how much current tax could this strategy save Jayzee? (Ignore any Social Security, Medicare, or self-employment tax issues.)How much income should be retained in the corporation? (Use tax rate schedule)

Nontax factors do not play an important role in tax planning.

If Jim invested $100,000 in an annual dividend-paying stock today with a 7 percent return, what investment time period will give Jim the greatest after-tax return?

Jason's employer pays year-end bonuses each year on December 31. Jason, a cash-basis taxpayer, would prefer not to pay tax on his bonus this year (and actually would prefer his daughter to pay tax on the bonus) . So, he leaves town on December 31, 2019, and has his daughter, Julie, pick up his check on January 2, 2020. Who reports the income and when?

If tax rates are decreasing:

Rodney, a cash-basis taxpayer, owes $72,500 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 32 percent and his after-tax rate of return is 6.5 percent. What tax rate next year will make Rodney indifferent between paying the $72,500 this year or next year? Use Exhibit 3.1. (Round discount factor(s)to three decimal places.)

Assume that Larry's marginal tax rate is 24 percent. If corporate bonds pay 10 percent interest, what interest rate would a municipal bond have to offer for Larry to be indifferent between the two bonds?