Deck 3: Tax Planning Strategies and Related Limitations

Question 1

8) The time value of money suggests that $1 in one year from now is worth less than $1 today.

Answer 1

True

Question 2

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

Answer 2

False
Explanation: Future Value = Present Value × (1 + r)ⁿ

Question 3

14) In general, tax planners prefer to defer income. This is an example of the conversion strategy.

Answer 3

False
Explanation: Deferring income is an example of the timing strategy.

Question 4

1) The goal of tax planning is tax minimization.

Question 5

13) Tax savings generated from deductions are considered cash inflows.

Question 6

5) In general, tax planners prefer to accelerate deductions.

Question 7

19) One limitation of the timing strategy is the difficulties in accelerating a tax deduction without accelerating the actual cash outflow that generates the tax deduction.

Question 8

11) When considering cash inflows, higher present values are preferred.

Question 9

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

Question 10

7) 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.

Question 11

4) The timing strategy is based on the idea that the location of where the income is taxed affects the tax costs of the income.

Question 12

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

Question 13

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

Question 14

6) The concept of present value is an important part of the timing strategy.

Question 15

3) Virtually every transaction involves the taxpayer and two other parties that have an interest in the tax ramifications of the transaction.

Question 16

15) The timing strategy is particularly effective for cash basis taxpayers.

Question 17

16) The timing strategy becomes more attractive as tax rates decrease.

Question 18

17) The timing strategy becomes more attractive as interest rates (i.e., rates of return) increase.

Question 19

12) When considering cash outflows, higher present values are preferred.

Question 20

20) The constructive receipt doctrine is a natural limitation for the conversion strategy.

Question 21

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

Question 22

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

Question 23

30) The conversion strategy capitalizes on the fact that tax rates vary across different activities.

Question 24

32) Implicit taxes may reduce the benefits of the conversion strategy.

Question 25

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

Question 26

28) The business purpose, step-transaction, and substance-over-form doctrines may limit the income shifting strategy.

Question 27

36) Tax evasion is a legal activity that forms the basis of the basic tax planning strategies.

Question 28

35) Tax avoidance is a legal activity that forms the basis of the basic tax planning strategies.

Question 29

25) The value of a tax deduction is higher for a taxpayer with a lower tax rate.

Question 30

26) The income shifting strategy requires taxpayers with varying tax rates.

Question 31

33) Investors must consider complicit taxes as well as explicit taxes in order to make correct investment choices.

Question 32

38) The goal of tax planning generally is to:

A) minimize taxes.
B) minimize IRS scrutiny.
C) maximize after-tax wealth.
D) support the Federal government.
E) None of the choices are correct.

Question 33

21) The constructive receipt doctrine is more of an issue for cash basis taxpayers.

Question 34

24) If tax rates will be higher next year, taxpayers should defer their income to next year regardless of their after-tax rate of return.

Question 35

39) Effective tax planning requires all of these considerations except:

A) nontax factors.
B) the taxpayer's tax costs of alternative transactions.
C) the other party's tax costs of alternative transactions.
D) the other party's nontax costs of alternative transactions.
E) all of the choices are required considerations.

Question 36

37) The downside of tax avoidance includes the potential of stiff monetary penalties and imprisonment.

Question 37

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

Question 38

40) Which is not a basic tax planning strategy?

A) Income shifting.
B) Timing.
C) Conversion.
D) Arms-length transaction.
E) None of the choices are correct.

Question 39

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

Question 40

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

Question 41

54) Which of the following does not limit the benefits of deferring income?

A) Increasing tax rates.
B) A taxpayer with severe cash flow needs.
C) If continuing an investment would generate a low rate of return.
D) If continuing an investment would subject the taxpayer to unnecessary risk.
E) None of the choices are correct.

Question 42

42) Assuming a positive interest rate, the present value of money suggests:

A) $1 today = $1 in one year.
B) $1 today > $1 in one year.
C) $1 today < $1 in one year.
D) $1 today ≤ $1 in one year.
E) None of the choices are correct.

Question 43

45) If Nicolai earns an 8% after-tax rate of return, $20,000 today would be worth how much to Nicolai in 5 years? Use Future value of $1. (Round present and future value factor(s) to 5 decimal places.) 

A) $20,000.
B) $13,620.
C) $18,520.
D) $21,600.
E) None of the choices are correct.

Question 44

57) If tax rates are decreasing:

A) taxpayers should accelerate income.
B) taxpayers should defer deductions.
C) taxpayers should defer income.
D) taxpayers should defer deductions and accelerate income.
E) None of the choices are correct.

Question 45

44) If Lucy earns a 6% after-tax rate of return, $8,000 received in four years is worth how much today? Use Exhibit 3.1. (Round present and future value amounts to 3 places) 

A) $8,000.
B) $7,544.
C) $8,989.
D) $6,336.
E) None of the choices are correct.

Question 46

49) If Julius has a 30% tax rate and a 10% after-tax rate of return, a $40,000 tax deduction in two years will save how much tax in today's dollars? Use Exhibit 3.1. (Round present and future value amounts to 3 places)

A) $40,000.
B) $9,912.
C) $33,040.
D) $12,000.
E) None of the choices are correct.

Question 47

43) If Joel earns a 10% after-tax rate of return, $10,000 received in two years is worth how much today? Use Exhibit 3.1. (Round present and future value amounts to 3 places)

A) $10,000.
B) $9,090.
C) $8,260.
D) $11,000.
E) None of the choices are correct.

Question 48

51) If Julius has a 20% tax rate and a 10% after-tax rate of return, $25,000 of income in three years will cost him how much tax in today's dollars? Use Exhibit 3.1. (Round present and future value amounts to 3 places)

A) $3,755.
B) $18,775.
C) $5,000.
D) $25,000.
E) None of the choices are correct.

Question 49

58) If tax rates are decreasing:

A) taxpayers should accelerate income.
B) taxpayers should defer deductions.
C) taxpayers should accelerate deductions.
D) taxpayers should defer deductions and accelerate income.
E) None of the choices are correct.

Question 50

60) Which of the following is not required to determine the best timing strategy?

A) The taxpayer's after-tax rate of return.
B) The taxpayer's tax rate this year.
C) The taxpayer's tax rate in future years.
D) The taxpayer's tax rate last year.
E) None of the choices are correct.

Question 51

52) Which of the following increases the benefits of income deferral?

A) Increasing tax rates.
B) Smaller after-tax rate of return.
C) Larger after-tax rate of return.
D) Smaller magnitude of transactions.
E) None of the choices are correct.

Question 52

55) The constructive receipt doctrine:

A) is particularly restrictive for accrual basis taxpayers.
B) causes income to be recognized before it is actually received.
C) causes income to be recognized after it is actually received.
D) applies equally to income and expenses.
E) None of the choices are correct.

Question 53

53) Which of the following decreases the benefits of accelerating deductions?

A) Decreasing tax rates.
B) Smaller after-tax rate of return.
C) Larger after-tax rate of return.
D) Larger magnitude of transactions.
E) None of the choices are correct.

Question 54

59) If tax rates are increasing:

A) taxpayers should accelerate income.
B) taxpayers should defer deductions.
C) taxpayers should defer income.
D) you need more information to make a recommendation.
E) None of the choices are correct.

Question 55

41) Which of the following tax planning strategies is based on the present value of money?

A) timing.
B) tax avoidance.
C) income shifting.
D) conversion.
E) None of the choices are correct.

Question 56

48) 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?

A) 1 year.
B) 5 years.
C) 10 years.
D) 20 years.
E) All yield the same after-tax return.

Question 57

46) If Scott earns a 12% after-tax rate of return, $15,000 today would be worth how much to Scott in 2 years? Future value of $1. (Round present and future value factor(s) to 5 decimal places.)

A) $15,000.
B) $11,955.
C) $18,520.
D) $18,816.
E) None of the choices are correct.

Question 58

50) 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)

A) $50,000.
B) $20,000.
C) $37,350.
D) $14,940.
E) None of the choices are correct.

Question 59

56) Rolando's employer pays year-end bonuses each year on December 31. Rolando, a cash basis taxpayer, would prefer to not pay tax on his bonus this year. So, he leaves town on December 31, 2017 and doesn't pick up his check until January 2, 2018. When should Rolando report his bonus?

A) 2018.
B) 2017.
C) Rolando can choose the year to report the income.
D) it does not matter.
E) None of the choices are correct.

Question 60

47) If Rudy has a 25% tax rate and a 6% 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 present and future value amounts to 3 places)

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

Question 61

79) Assume that Lucas' marginal tax rate is 30% and his tax rate on dividends is 15%. If a dividend-paying stock (with no growth potential) pays an 8% 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?

A) 30.00%.
B) 15.00%.
C) 8.00%.
D) 6.80%.
E) None of the choices are correct.

Question 62

77) Assume that Marsha is indifferent between investing in a city of Destin bond that pays 6% interest and a corporate bond that pays 8% interest. What is Marsha's marginal tax rate?

A) 50%.
B) 40%.
C) 30%.
D) 20%.
E) None of the choices are correct.

Question 63

67) A common income shifting strategy is to:

A) shift income from low tax rate taxpayers to high tax rate taxpayers.
B) shift deductions from low tax rate taxpayers to high tax rate taxpayers.
C) shift deductions from high tax rate taxpayers to low tax rate taxpayers.
D) accelerate tax deductions.
E) None of the choices are correct.

Question 64

73) 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?

A) 30.00%.
B) 10.40%.
C) 8.00%.
D) 7.00%.
E) None of the choices are correct.

Question 65

75) 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) 25.00%.
B) 12.50%.
C) 10.00%.
D) 7.50%.
E) None of the choices are correct.

Question 66

78) Assume that Javier is indifferent between investing in a city of El Paso bond that pays 5% interest and a corporate bond that pays 6.25% interest. What is Javier's marginal tax rate?

A) 50%.
B) 40%.
C) 30%.
D) 20%.
E) None of the choices are correct.

Question 67

72) Which of the following may limit the conversion strategy?

A) Implicit taxes.
B) Assignment of income doctrine.
C) Constructive receipt doctrine.
D) Activities with preferential tax rates.
E) None of the choices are correct.

Question 68

80) 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?

A) 15.00%.
B) 10.00%.
C) 9.00%.
D) 7.65%.
E) None of the choices are correct.

Question 69

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

A) Taxpayers with varying tax rates.
B) Decreasing tax rates.
C) Increasing tax rates.
D) Unrelated taxpayers.
E) None of the choices are correct.

Question 70

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

A) Assignment of income doctrine.
B) Business purpose doctrine.
C) Substance-over-form doctrine.
D) Step-transaction doctrine.
E) None of the choices are correct.

Question 71

76) Assume that Lavonia's marginal tax rate is 20%. If a city of Tampa bond pays 5% interest, what interest rate would a corporate bond have to offer for Lavonia to be indifferent between the two bonds?

A) 20%.
B) 8%.
C) 7%.
D) 4%.
E) None of the choices are correct.

Question 72

70) Which of the following is an example of the income shifting strategy?

A) A corporation paying its shareholders a $20,000 dividend.
B) A corporation paying its owner a $20,000 salary.
C) A high tax rate taxpayer investing in tax exempt municipal bonds.
D) A cash-basis business delaying billing its customers until after year end.
E) None of the choices are correct.

Question 73

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

A) A cash basis taxpayer paying all outstanding bills by year end.
B) A parent employing her child in the family business.
C) A business paying its owner a $30,000 salary.
D) A taxpayer investing in a tax preferred investment.
E) None of the choices are correct.

Question 74

65) A taxpayer instructing her son to collect rent checks for the taxpayer's property and to report this as taxable income on the son's tax return violates which doctrine?

A) Constructive receipt doctrine.
B) Implicit tax doctrine.
C) Assignment of income doctrine.
D) Step-transaction doctrine.
E) None of the choices are correct.

Question 75

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

A) A corporation paying its shareholders a $20,000 dividend.
B) A corporation paying its owner a $20,000 salary.
C) A high tax rate taxpayer investing in tax exempt municipal bonds.
D) A cash-basis business delaying billing its customers until after year end.
E) None of the choices are correct.

Question 76

68) Jason's employer pays year-end bonuses each year on December 31. Jason, a cash basis taxpayer, would prefer to not 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, 2017 and has his daughter, Julie, pick up his check on January 2, 2018. Who reports the income and when?

A) Julie in 2017.
B) Julie in 2018.
C) Jason in 2017.
D) Jason in 2018.
E) None of the choices are correct.

Question 77

69) Which of the following is more likely to receive IRS scrutiny under the assignment of income doctrine?

A) A corporation paying its shareholders a $20,000 dividend.
B) A parent employing her child in the family business.
C) A taxpayer gifting stock to his children.
D) A cash-basis business delaying billing its customers until after year end.
E) None of the choices are correct.

Question 78

74) 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) 30.00%.
B) 10.00%.
C) 6.00%.
D) 3.60%.
E) None of the choices are correct.

Question 79

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

A) Constructive receipt doctrine.
B) Implicit tax doctrine.
C) Substance-over-form doctrine.
D) Step-transaction doctrine.
E) None of the choices are correct.

Question 80

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

A) A corporation paying its shareholders a $20,000 dividend.
B) A parent employing her child in the family business.
C) A taxpayer gifting stock to his children.
D) A cash-basis business delaying billing its customers until after year end.
E) None of the choices are correct.