Deck 4: Maxims of Income Tax Planning

Question 1

The after-tax cost of a dollar of deductible expense to a high-tax entity is less than the after-tax cost to a low-tax entity.

Answer 1

True

Question 2

Planning opportunities are created when the tax law applies differentially to alternative business transactions.

Answer 2

True

Question 3

Income-shifting transactions occur more frequently between related parties than between unrelated parties.

Answer 3

True

Question 4

Opportunity cost refers to the decrease in NPV from a deferral of the receipt of before-tax cash flows.

Question 5

The tax law applies uniformly to every commercial transaction by every business entity.

Question 6

Tax evasion is a federal crime punishable by imprisonment.

Question 7

In the United States, individuals and corporations are the two entities that pay tax on business income.

Question 8

The after-tax value of a dollar of income to a high-tax entity is more than the after-tax value to a low-tax entity.

Question 9

Tax avoidance is the reduction of a person's tax liability through illegal means.

Question 10

The goal of tax planning is to reduce tax costs or increase tax savings as much as possible.

Question 11

The assignment of income doctrine constraints tax deferral strategies.

Question 12

Deduction-shifting transactions usually occur between unrelated taxpayers.

Question 13

Corporations, LLCs, and partnerships are all taxable entities.

Question 14

Both the individual and the corporate federal income tax rates are progressive.

Question 15

The entity variable is important because the amount of taxable income generated by a business depends on the type of entity conducting the business.

Question 16

Andrea Mitchell can shift income to her daughter, Lynn, by endorsing a check for $10,000 received for a client over to Lynn.

Question 17

According to the assignment of income doctrine, income must be taxed to the person receiving the cash from an income-generating transaction.

Question 18

A planning strategy that defers a tax cost without deferring the receipt of before-tax cash flows decreases the NPV of the transaction.

Question 19

A strategy to shift income from one taxpayer to a different taxpayer reflects the entity variable, while a strategy to shift income from one year to a different year reflects the time period variable.

Question 20

The time period variable is based on the time value of money.

Question 21

Hilex Inc. structures a transaction to shift income from one controlled subsidiary to another controlled subsidiary. This tax planning strategy may be taking advantage of the:

A) Jurisdiction variable
B) Time period variable
C) Entity variable
D) Character variable

Question 22

Hilex Inc. liquidates its investment in General Electric corporate bonds and reinvests the proceeds in City of Miami municipal bonds. This tax planning strategy may be taking advantage of the:

A) Character variable
B) Entity variable
C) Time period variable
D) Jurisdiction variable

Question 23

The tax character of an item of income can change when Congress amends the tax law.

Question 24

Hilex Inc. structures a transaction to shift income from its 20Y0 tax year to its 20Y2 tax year. This tax planning strategy may be taking advantage of the:

A) Character variable
B) Entity variable
C) Time period variable
D) Jurisdiction variable

Question 25

Mrs. Day structures a transaction to convert income from ordinary income to capital gain. This tax planning strategy may be taking advantage of the:

A) Entity variable
B) Time period variable
C) Jurisdiction variable
D) Character variable

Question 26

Mrs. Day structures a transaction to shift income from her sole proprietorship to her grandson's business. This tax planning strategy may be taking advantage of the:

A) Entity variable
B) Time period variable
C) Jurisdiction variable
D) Character variable

Question 27

Which of the following statements about tax planning is false?

A) The goal of tax planning is tax minimization.
B) Tax planning involves structuring transactions to reduce tax costs or increase tax savings.
C) Sound tax planning ideas should be entirely legal.
D) None of the above is false.

Question 28

Hilex Inc. structures a transaction to shift income from its California office to its Oregon office. This tax planning strategy may be taking advantage of the:

A) Character variable
B) Time period variable
C) Entity variable
D) Jurisdiction variable

Question 29

A taxpayer should prefer to pay a $100 implicit tax rather than a $100 explicit tax.

Question 30

Tax planning strategies to enhance NPV must reflect all four tax planning maxims.

Question 31

A reduced market rate of return on a tax-favored investment is called an implicit tax.

Question 32

The business purpose doctrine allows the IRS to collapse a series of intermediate transactions into a single transaction to determine the tax consequences of the arrangement in its entirety.

Question 33

The substance over form doctrine allows the IRS to look through the legal formalities of a transaction to determine its true economic nature.

Question 34

The tax character of an item of income depends on how the income is reported on the firm's financial statements.

Question 35

Which of the following statements about tax avoidance and tax evasion is false?

A) Tax avoidance is legal, while tax evasion is illegal.
B) The difference between avoidance and evasion is clearly defined in the tax law.
C) Tax evasion is a federal felony offence.
D) Taxpayers should not regard tax avoidance as unethical.

Question 36

Municipal bond investments bear less implicit tax than investments in taxable corporate bonds.

Question 37

The 15% preferential tax rate on capital gains has the same value to every individual taxpayer.

Question 38

Mrs. Day structures a transaction to shift income from her New York business to her New Hampshire business. This tax planning strategy may be taking advantage of the:

A) Entity variable
B) Time period variable
C) Jurisdiction variable
D) Character variable

Question 39

The rate at which an item of income is taxed depends on the tax character of the income.

Question 40

Mrs. Day structures a transaction to shift income from her 20Y1 tax year to her 20Y2 tax year. This tax planning strategy may be taking advantage of the:

A) Entity variable
B) Time period variable
C) Jurisdiction variable
D) Character variable

Question 41

Which of the following entities is not a taxable entity for federal income tax purposes?

A) Mr. Bob Clark, a U.S. citizen and resident of West Virginia
B) PTS Limited, an Arizona partnership
C) Confad Inc., an Oklahoma corporation listed on Nasdaq
D) All of the above are taxable entities.

Question 42

Which of the following statements about the time period variable is false?

A) If Congress replaced the current progressive income tax rates with a proportionate rate applying to all taxpayers, the time period variable would no longer be a factor in tax planning.
B) The time period variable becomes more important as the taxpayer's discount rate for computing NPV increases.
C) Tax planning strategies based on the time period variable must involve at least two different taxable years.
D) Tax planning strategies based on the time period variable reflect the time value of money.

Question 43

Which of the following statements about tax deferral is true?

A) The value of tax deferral increases as the taxpayer's discount rate for computing NPV decreases.
B) Tax deferral is not an effective planning strategy if the taxpayer's marginal tax rate is stable over time.
C) The greater the length of time that the payment of a tax is deferred, the less the tax costs in NPV terms.
D) Both A. and C. are true.

Question 44

The tax law provides that individuals do not pay tax on the first $250,000 of gain realized on the sale of a principal residence. This rule is an example of the:

A) Entity variable
B) Time period variable
C) Jurisdiction variable
D) Character variable

Question 45

Mrs. Reid made a gift to her 19-year old daughter Susan. Mrs. Reid's marginal tax rate is 35%, and Susan's marginal tax rate is 10%. Which of the following statements is true?

A) The gift consisted of a corporate bond that paid $10,000 interest to Susan this year. Even though Susan is the owner of the bond, Mrs. Reid must include the $10,000 in her taxable income.
B) The gift consisted of a $2,600 rent check written by tenants who lease a duplex owned by Mrs. Reid. Even though Susan cashed the check, Mrs. Reid must include the $2,600 in her taxable income.
C) The gift consisted of a lottery ticket. Six weeks after the gift, the ticket was drawn as a winner. Even though Susan received the $50,000 taxable prize because she was the rightful owner of the ticket, Mrs. Reid must include $50,000 in her taxable income.
D) None of the above is true.

Question 46

Mr. Blau structured an income-generating transaction so that the $90,000 income and cash flow shifted to Mr. Blau's sister, Kim. If Mr. Blau's marginal tax rate is 35%, and Kim's tax rate is 15%, compute the tax savings from the income shift.

A) $13,500
B) $21,500
C) $31,500
D) None of the above

Question 47

Mr. Crum, an architect, billed a client $12,500 for professional services rendered. When Mr. Crum received a check in full payment from the client, he endorsed the check and mailed it to his college-age son, Paul, who cashed it and deposited the $12,500 in his own bank account. Which of the following statements is a correct application of the assignment of income doctrine?

A) Mr. Crum must report $12,500 income on his tax return because he earned it.
B) Paul must report $12,500 income on his tax return because he received the cash.
C) It is illegal for Mr. Crum to transfer the check to Paul.
D) Mr. Crum and Paul may decide which one of them reports $12,500 income on his tax return.

Question 48

Which of the following statements is true?

A) Mary Gilly owns 100% of the stock of Gilly Inc. Both Mary and Gilly Inc. are taxpayers under federal law.
B) The same rate schedule applies to both individual and corporate taxpayers.
C) The tax provisions governing the computation of individual business income are separate and distinct from the tax provisions governing the computation of corporate business income.
D) Mary Gilly owns 100% of the stock to Gilly Inc. Both Mary and Gilly Inc. are taxpayers under federal law and the tax provisions governing the computation of individual business income are separate and distinct from the tax provisions governing the computation of corporate business income.

Question 49

Pratt Company structured an income-generating transaction so that the $750,000 income and cash flow shifted to Pratt's wholly owned subsidiary, PTB Company. If Pratt's marginal tax rate is 40%, and PTB's tax rate is 15%, compute the tax savings from the income shift.

A) $300,000
B) $250,000
C) $187,500
D) $112,500

Question 50

JNC Company structured an income-generating transaction so that the income and cash flow shifted to Juno Inc. Presuming that JNC makes rational decisions, which of the following statements is false?

A) JNC and Juno must be related parties that share a mutual economic interest.
B) JNC's marginal tax rate is higher than Juno's marginal tax rate.
C) The income shift should increase the NPV of the transaction.
D) None of the above is false.

Question 51

The assignment of income doctrine holds that:

A) Income from a transaction must be taxed to the person who receives the cash from the transaction.
B) Income from a transaction must be taxed to the person who reports the transaction on his or her tax return.
C) Income from a transaction must be taxed to the person that earns the income.
D) None of the above

Question 52

Mr. Dole needed to sell appreciated stock out of his investment portfolio to generate cash to pay for his Christmas spending. He decided to postpone the sale from December 20Y1 until January 20Y2. Mr. Dole is taking advantage of the:

A) Entity variable
B) Time period variable
C) Jurisdiction variable
D) Character variable

Question 53

A taxpayer who invests in a growth stock rather than a stock that pays an annual dividend is engaging in tax planning based on the:

A) Entity variable
B) Time period variable
C) Jurisdiction variable
D) Character variable

Question 54

Mrs. Bern's marginal tax rate is 33%, and her grandson Jeff's marginal tax rate is 10%. Which of the following statement is false?

A) The family could save 23 cents of tax for every dollar of deduction shifted from Jeff to Mrs. Bern.
B) The family could save 23 cents of tax for every dollar of income shifted from Mrs. Bern to Jeff.
C) Any income shift from Mrs. Bern to Jeff is constrained by the assignment of income doctrine.
D) None of the above is false.

Question 55

Varson Inc. and Vonsell Inc. are owned by the same family. The family decides to purchase $150,000 of deductible advertising that will benefit the businesses operated by both corporations. Which of the following statements is true?

A) If Varson's marginal tax rate is higher than Vonsell's marginal tax rate, Vonsell should purchase the advertising to minimize after-tax cost.
B) If Varson's marginal tax rate is higher than Vonsell's marginal tax rate, the tax law requires Vonsell to purchase the advertising.
C) If Varson's marginal tax rate is higher than Vonsell's marginal tax rate, Varson can claim a $150,000 deduction on its tax return regardless of which corporation purchases the advertising.
D) None of the above is true.

Question 56

Which of the following statements about the entity variable is false?

A) If Congress replaced the current progressive income tax rates with a proportionate rate applying to all taxpayers, the entity variable would no longer be a factor in tax planning.
B) The entity variable becomes more important when Congress increases the progressivity of the income tax.
C) Tax planning strategies based on the entity variable must involve at least two different taxpayers.
D) Tax planning strategies based on the entity variable must involve some type of income taxed at a preferential rate.

Question 57

The income tax consequences of a business transaction depend on which entity engages in the transaction because:

A) The amount of income from the transaction depends on which type of entity engaged in the transaction.
B) The transaction may be taxable or nontaxable depending on which type of entity engaged in the transaction.
C) The rate at which the income from the transaction is taxed depends on which type of entity engaged in the transaction.
D) The character of the income from the transaction depends on which type of entity engaged in the transaction.

Question 58

OWB Inc. and Owin Inc. are owned by the same family. OWB's marginal tax rate is 40%, and Owin's marginal tax rate is 25%. OWB has the opportunity to engage in a transaction that will generate $250,000 taxable cash flow. Alternatively, Owin could engage in the transaction. However, Owin would incur an extra $60,000 deductible cash expense with respect to the transaction. Which of the following statements is true?

A) Because OWB and Owin are owned by the same family, the family is indifferent as to which corporation engages in the transaction.
B) OWB should engage in the transaction to generate $7,500 more after-tax cash flow.
C) OWB should engage in the transaction to avoid the extra expense.
D) Owin should engage in the transaction because it has the lower marginal tax rate.

Question 59

Carter Inc. and CCC Inc. are owned by the same family. Carter's marginal tax rate is 30%, and CCC's marginal tax rate is 20%. Carter has the opportunity to engage in a transaction that will generate $500,000 taxable cash flow. Alternatively, CCC could engage in the transaction. However, CCC would incur an extra $42,500 deductible cash expense with respect to the transaction. Which of the following statements is true?

A) CCC should engage in the transaction to generate $16,000 more after-tax cash flow.
B) Carter should engage in the transaction to avoid the extra expense.
C) CCC should engage in the transaction because it has the lower marginal tax rate.
D) Because Carter and CCC are owned by the same family, the family is indifferent as to which corporation engages in the transaction.

Question 60

The time period variable reflects the fact that:

A) Federal income tax rules are not stable over time.
B) A tax dollar paid this year cost more than a tax dollar paid in a future year.
C) A taxpayer's marginal rate next year may be more or less than the current marginal rate.
D) None of the above

Question 61

Which of the following statements about the character variable is true?

A) The tax character of income is determined strictly by tax law.
B) The tax character of income cannot change from year to year.
C) Tax planning strategies based on the character variable must involve at least two different taxpayers.
D) The tax character of income cannot change from year to year and tax planning strategies based on the character variable must involve at least two different taxpayers.

Question 62

Which of the following statements about the jurisdiction variable is true?

A) Most businesses are subject to the taxing jurisdiction of more than one government.
B) For federal purposes, state income taxes are deductible in the computation of taxable income.
C) Businesses can often minimize total tax burden by conducting business in jurisdictions with favorable tax climates.
D) All of the above statements are true.

Question 63

Mr. Cox has the choice between two transactions. Transaction A will generate $500,000 taxable cash flow in the current year (year 0). Transaction B will generate $460,000 cash flow in the current year, but Mr. Cox will not be required to report $460,000 income until next year (year 1). Mr. Cox has a 40% marginal tax rate and uses a 10% discount rate to compute NPV. Which of the following statements is true?

A) Mr. Cox should choose transaction A because it generates more before-tax cash flow.
B) Mr. Cox should choose transaction A because its NPV exceeds transaction B's NPV.
C) Mr. Cox should choose transaction B because the tax cost is deferred one year.
D) Mr. Cox should choose transaction B because its NPV exceeds transaction A's NPV.

Question 64

Acme Inc. is planning a transaction that requires a $100,000 deductible cash expenditure. The transaction is structured so that Acme will pay the cash and report the deduction this year (year 0). Compute the increase in the NPV of the transaction if it can be restructured so that Acme will report the deduction this year, but pay the cash three years later (year 3). Acme's marginal tax rate is 35%, and it uses a 7% discount rate to compute NPV.

A) $15,928
B) $18,400
C) $21,516
D) None of the above

Question 65

Bailey Inc. is planning a transaction that requires a $60,000 deductible cash expenditure. The transaction is structured so that Bailey will pay the cash and report the deduction this year (year 0). Compute the increase in the NPV of the transaction if it can be restructured so that Bailey will report the deduction this year, but pay the cash two years later (year 2). Bailey's marginal tax rate is 25%, and it uses a 9% discount rate to compute NPV.

A) $8,677
B) $9,014
C) $9,480
D) None of the above

Question 66

Which of the following statements about ordinary income and capital gain is true?

A) Income characterized as capital gain can have no additional tax characteristics.
B) Individuals pay tax on their capital gains at a preferential rate.
C) Corporations pay tax on both ordinary income and capital gain at their regular rate.
D) Individuals pay tax on their capital gains at a preferential rate and corporations pay tax on both ordinary income and capital gain at their regular rate.

Question 67

Mrs. James plans to invest in one of two investment alternatives having the same risk. Investment 1 has a before-tax return of 10% and the income from investment 1 would be taxed at Mrs. James' 35% regular tax rate. Investment 2 has a before-tax return of 8% and the income from investment 2 would be taxed at a 15% preferential rate. Which of the following statements regarding these investment choices is false?

A) The after-tax rate of return on investment 1 is 6.5%.
B) The after-tax rate of return on investment 2 is 6.8%.
C) Investment 2 bears implicit tax relative to investment 1.
D) Mrs. James should choose investment 1.

Question 68

Mrs. Lester has the choice between two transactions. Transaction A will generate $175,000 taxable cash flow in the current year (year 0). Transaction B will generate $160,000 cash flow in the current year, but Mrs. Lester will not be required to report $160,000 income for two years (year 2). Mrs. Lester has a 40% marginal tax rate and uses a 9% discount rate to compute NPV. Which of the following statements is true?

A) Mrs. Lester should choose transaction A because it generates more before-tax cash flow than transaction B
B) Mrs. Lester should choose transaction A because its NPV exceeds transaction B's NPV.
C) Mrs. Lester should choose transaction B because the tax cost is deferred one year.
D) Mrs. Lester should choose transaction B because its NPV exceeds transaction A's NPV.

Question 69

Mr. Hayes plans to pay $100,000 for one of three investment alternatives that have the same risk. The income from investment 1 would be taxed at Mr. Hayes' 25% regular tax rate, the income from investment 2 would be taxed at a 15% preferential rate, and the income from investment 3 is tax-exempt. The investments offer the following before-tax yields. Investment 1: 9.0%
Investment 2: 7.5%
Investment 3: 6.0%
Which investment should Mr. Hayes select?

A) Investment 1
B) Investment 2
C) Investment 3
D) Mr. Hayes is neutral between investment 2 and investment 3.

Question 70

Which of the following statements about implicit and explicit taxes is false?

A) The amount of implicit tax on an investment depends on the owner's marginal tax rate.
B) The taxpayer pays an explicit tax to the taxing jurisdiction.
C) An investment yielding ordinary income taxed at the regular tax rates should not have an implicit tax.
D) None of the above is false.

Question 71

Mr. Erske plans to pay $100,000 for one of three investment alternatives that have the same risk. The income from investment 1 would be taxed at Mr. Erske's 30% regular tax rate, the income from investment 2 would be taxed at a 15% preferential rate, and the income from investment 3 is tax-exempt. The investments offer the following before-tax yields. Investment 1: 8.5%
Investment 2: 7.5%
Investment 3: 6.0%
Which investment should Mr. Erske select?

A) Investment 1
B) Investment 2
C) Investment 3
D) Mr. Erske is neutral between investment 2 and investment 3.

Question 72

NWR Inc. is structuring a transaction that will require a $200,000 deductible cash expenditure. Which of the following structures is the most effective in terms of the time period variable?

A) NWR will pay the cash and report the deduction in 20Y1.
B) NWR will pay the cash and report the deduction in 20Y2.
C) NWR will pay the cash in 20Y2 and report the deduction in 20Y1.
D) NWR will pay the cash in 20Y1 and report the deduction in 20Y2.

Question 73

Which of the following statements about ordinary income and capital gain is false?

A) Every item of income is ultimately characterized as either ordinary income or capital gain for federal tax purposes.
B) Most ordinary income items are taxed at the regular individual or corporate tax rates.
C) Individuals and corporations pay tax on their capital gains at a preferential rate.
D) None of the above is false.

Question 74

Hubern Inc. is planning a transaction that will generate $275,000 taxable income and cash inflow. The transaction is structured so that Hubern will receive the cash and report the income this year (year 0). Compute the increase in the NPV of the transaction if it can be restructured so that Hubern will receive the cash this year, but report the income one year later (year 1). Hubern's marginal tax rate is 40%, and it uses a 9% discount rate to compute NPV.

A) $6,276
B) $8,933
C) $9,130
D) None of the above

Question 75

Jelk Company is structuring a transaction that will generate $140,000 taxable revenue and cash inflow. Which of the following structures is the most effective in terms of the time period variable?

A) Jelk will receive the cash and report the income in 20Y1.
B) Jelk will receive the cash in 20Y2 and report the income in 20Y1.
C) Jelk will receive the cash and report the income in 20Y2.
D) Jelk will receive the cash in 20Y1 and report the income in 20Y2.

Question 76

Mr. Fox has $200,000 to invest. He could buy corporate bonds with a 10% before-tax yield or tax-exempt bonds with an 8% before-tax yield. Which of the following statements is false?

A) If Mr. Fox invests in the tax-exempt bonds, he will pay $4,000 implicit tax every year.
B) If Mr. Fox's marginal tax rate is 15%, he should invest in the corporate bonds.
C) If Mr. Fox's marginal tax rate is 40%, he should invest in the tax-exempt bonds.
D) None of the above is false.

Question 77

Mrs. Jax plans to pay $100,000 for one of three investment alternatives that have the same risk. The income from investment 1 would be taxed at Mrs. Jax's 30% regular tax rate, the income from investment 2 would be taxed at a 20% preferential rate, and the income from investment 3 is tax-exempt. The investments offer the following before-tax yields. Investment 1: 8.25%
Investment 2: 7.5%
Investment 3: 6.0%
Which investment should Mrs. Jax select?

A) Investment 1
B) Investment 2
C) Investment 3
D) Mrs. Jax is neutral between investment 2 and investment 3.

Question 78

A taxpayer may choose to accept a reduced market rate of return on an investment to take advantage of a tax preference associated with the investment. In such case, the taxpayer will pay a/an:

A) Excise tax
B) Explicit tax
C) Implicit tax
D) Transaction tax

Question 79

Mrs. Stout has a $35,000 capital gain eligible for a 28% preferential tax rate. Which of the following statements is false?

A) If Mrs. Stout's regular marginal tax rate is 15%, she can elect to recharacterize the capital gain as ordinary income.
B) If Mrs. Stout's regular marginal tax rate is 25%, the preferential tax rate has no value to her.
C) If Mrs. Stout's regular marginal tax rate is 35%, the preferential tax rate saves her $2,450 in tax.
D) None of the above is false.

Question 80

Sancel Inc. is planning a transaction that will generate $70,000 taxable income and cash inflow. The transaction is structured so that Sancel will receive the cash and report the income this year (year 0). Compute the increase in the NPV of the transaction if it can be restructured so that Sancel will receive the cash this year, but report the income two years later (year 2). Sancel's marginal tax rate is 30%, and it uses a 10% discount rate to compute NPV.

A) $3,654
B) $5,318
C) $8,526
D) None of the above