Deck 24: Taxation of Business Income

Question 1

A periodic payment investors receive from the company per share owned is a(n):

A) dividend.
B) capital gain.
C) economic profit.
D) accounting profit.

Answer 1

dividend.

Question 2

Limited liability:

A) means that there are tight limits on the damages that a firm can be forced to pay due to lawsuits over product safety and so on.
B) means that the owners of a firm cannot personally be held responsible for the obligations of the firm.
C) is the major disadvantage of incorporation.
D) is the major advantage of proprietorship.

Answer 2

means that the owners of a firm cannot personally be held responsible for the obligations of the firm.

Question 3

The rate at which capital investments lose their value over time is called __________.Deducting the entire cost of the investment from taxes in the year in which the purchase was made is called __________.

A) depreciation; tax fraud
B) depreciation; expensing investments
C) an investment tax credit; depreciation
D) an investment tax credit; tax fraud

Answer 3

depreciation; expensing investments

Question 4

Which statement describes the major advantage of incorporation?

A) Incorporation solves the agency problem.
B) Income tax rates are significantly lower.
C) The owners of the firm cannot be held personally responsible for the obligations of the firm.
D) Expenses can be deducted from income.

Question 5

In 1960,the share of federal tax revenues earned by the corporate income tax was approximately _________.In 2011,the share of federal tax revenues earned by the corporate income tax was approximately _________.

A) 7%; 23%
B) 23%; 13%
C) 35%; 12%
D) 35%; 4%

Question 6

Which statement about corporate taxation is TRUE?

A) A tax on pure (economic)profit causes a firm to reduce output and employment.
B) Currently,corporations are not part of the tax base in the U.S.
C) If corporations are not taxed on their earnings but people are taxed on corporate payouts,there is a subsidy to corporate earnings relative to other types of saving.
D) If corporations are taxed on their earnings but people are not taxed on corporate payouts,there is a subsidy to corporate earnings relative to other types of saving.

Question 7

Which term refers to the difference between a firm's revenues and its reported costs of production?

A) dividend
B) pure profit
C) economic profit
D) accounting profit

Question 8

Suppose a corporation purchases an asset for $100,000.Under straight-line depreciation,the corporation would be allowed to depreciate the asset over 5 years.Under accelerated straight-line depreciation,it would be allowed to depreciate the asset over 2 years.Now assume that the discount rate is 10%.What would the present discounted value of the tax deduction be under straight-line depreciation?

A) $83,397.31
B) $90,909.09
C) $93,354.55
D) $100,000

Question 9

The separation of the ownership of the firm from the control of the firm leads to:

A) debt financing.
B) equity financing.
C) depreciation.
D) an agency problem.

Question 10

Suppose a corporation purchases an asset for $100,000.Under straight-line depreciation,the corporation would be allowed to depreciate the asset over 5 years.Under accelerated straight-line depreciation,it would be allowed to depreciate the asset over 2 years.What must the discount rate be such that the corporation is indifferent between straight-line depreciation and accelerated straight-line depreciation?

A) -10%
B) 0%
C) 5%
D) 10%

Question 11

Which of the following is NOT a method to finance a firm's investment?

A) debt financing
B) equity financing
C) retained earning
D) dividends

Question 12

The difference between a firm's revenues and its opportunity costs of production is a(n):

A) capital gain.
B) pure profit.
C) economic profit.
D) accounting profit.

Question 13

Corporate taxes can be calculated based on:

A) Taxes = ([Revenues - Expenses] × tax rate)- Tax Credits
B) Taxes = ([Revenues - Expenses] × [1 - tax rate])- Tax Credits
C) Taxes = ([Revenues - Expenses] × [1 - tax rate])+ Tax Credits
D) Taxes = ([Revenues - Expenses] × tax rate)+ Tax Credits

Question 14

Firms pay taxes on __________.An optimal tax on corporate profit would be levied on _________.

A) economic profits; dividends
B) economic profits; accounting profits
C) capital gains; economic profits
D) accounting profits; economic profits

Question 15

_____ is the raising of funds by selling _____.

A) Debt finance; bonds
B) Debt finance; stocks
C) Equity finance; bonds
D) Equity finance; IOUs

Question 16

A return that exceeds a firm's payouts to its factors of production is a(n):

A) dividend.
B) capital gain.
C) pure profit.
D) accounting profit.

Question 17

A straight-line depreciation schedule allows an asset to be deducted from earnings more _______ than an accelerated depreciation schedule,and more _________ than expensing the investment.

A) quickly; quickly
B) quickly; slowly
C) slowly; slowly
D) slowly; quickly

Question 18

_________ are people who have purchased ownership stakes in a company,and _________ are a group of people who meet periodically to review decisions made by a firm's management and report to the broader set of owners on management's performance.

A) Corporate executives; shareholders
B) Shareholders; corporate executives
C) Corporate executives; the board of directors
D) Shareholders; the board of directors

Question 19

Which term refers to the increase in the price of a share since its purchase?

A) dividend
B) capital gain
C) pure profit
D) economic profit

Question 20

The amount of money that firms can deduct from their taxes to account for capital investment depreciation is called:

A) a depreciation credit.
B) a depreciation allowance.
C) economic depreciation.
D) a depreciation schedule.

Question 21

If a firm finances investment by selling equity,which statement is TRUE?

A) The firm faces a greater risk of bankruptcy since stockholders must be paid no matter what.
B) The firm pays no corporate tax on income distributed to investors through dividends.
C) The firm has a choice of paying dividends or retaining earnings for reinvestment.
D) There are no significant differences between equity financing and debt financing.

Question 22

Allowing the deduction of depreciation allowances ___________ for a given level of investment; taxing corporate investment ___________ for a given level of investment.

A) lowers the marginal cost; lowers the marginal cost
B) lowers the marginal cost; increases the marginal benefit
C) lowers the marginal cost; lowers the marginal benefit
D) increases the marginal benefit; lowers the marginal cost

Question 23

Because the demand for the products produced by corporations is not likely to be perfectly elastic,it is likely that a tax on corporate profit will result in:

A) higher product prices,causing some of the tax burden to fall on consumers.
B) lower product prices,so none of the tax burden falls on consumers.
C) higher product prices,so none of the tax burden falls on consumers.
D) lower product prices,causing some of the tax burden to fall on consumers.

Question 24

Which of the following statements is TRUE?

A) There has traditionally been a tax advantage to paying dividends over capital gains.
B) Investors like to be paid in dividends despite the tax inefficiency because of the agency problem.
C) High-dividend taxes typically push firms to choose equity financing instead of debt financing.
D) There is no reason for corporations or investors to have a preference between paying dividends or reinvesting profits.

Question 25

Under current tax law,U.S.corporations are:

A) not permitted to claim tax payments to foreign governments as a credit against U.S.taxes.
B) permitted to claim tax payments to foreign governments as a credit against U.S.taxes.
C) exempt from the corporate income tax if they have production facilities located abroad.
D) required to pay both foreign taxes and U.S.taxes with no credits.

Question 26

If a firm finances investment by selling bonds,then the:

A) bondholders pay dividend tax on the interest they later receive.
B) bondholders pay personal income tax on the interest they later receive.
C) firm pays corporate tax on the amount they repay to the bondholders.
D) firm pays corporate tax on the amount they borrow from bondholders.

Question 27

If corporations bear at least some of the tax burden when profits are taxed,this means that workers are likely to bear some of the burden through:

A) higher wages if labor supply is not perfectly elastic.
B) higher wages if labor supply is perfectly elastic.
C) lower wages if labor supply is not perfectly elastic.
D) lower wages if labor supply is perfectly elastic.

Question 28

Which of the following groups is unlikely to bear the burden of a corporate tax in the long run?

A) consumers
B) capital owners
C) domestic workers
D) foreign workers

Question 29

What is the effective corporate tax rate when the value of the tax credit for each dollar of investment is $0.25,the tax rate on earnings minus labor is 35%,and the present discounted value of a $1 investment is $0.50?

A) -11.53%
B) -10%
C) 10%
D) 88.46%

Question 30

Which statement about the benefits of an investment is generally assumed to be TRUE in economic models?

A) The marginal product of capital is increasing.
B) The marginal product of capital is constant.
C) The marginal product of capital is diminishing.
D) The marginal product of capital is equal to the marginal product of labor.

Question 31

Which kind of depreciation is the TRUE deterioration in the value of capital in each period of time?

A) depreciation credits
B) depreciation allowances
C) economic depreciation
D) depreciation schedule

Question 32

U.S.firms are taxed on profits earned in other countries:

A) during the tax year when the profits are earned.
B) only when the foreign country collects no tax.
C) when the income is repatriated from the foreign subsidiary to the U.S.parent company.
D) at much higher rates than they are taxed on profits earned domestically.

Question 33

In a world without taxes,suppose that a firm finances an investment through selling equity shares on which it has to pay a dividend per dollar of investment equal to d.The total cost of a $1 investment each period is:

A) the rate of depreciation.
B) d.
C) the rate of depreciation plus d.
D) d minus the rate of depreciation.

Question 34

Why do governments levy corporate taxes on firms rather than taxing the factors of production that make up those firms? Discuss the two fundamental reasons.

Question 35

Suppose there is a corporate tax on cash earnings minus labor costs.As a result:

A) the return per dollar of investment per period is smaller for a given level of investment than it would be without the tax.
B) the marginal cost of investment is higher than it would be without the tax.
C) firms invest more than they would without the tax.
D) the return per dollar of investment per period is larger for a given level of investment than it would be without the tax.

Question 36

A profit-maximizing corporation would generally prefer _____ to _____.

A) straight-line depreciation; accelerated depreciation
B) expensing investments; accelerated depreciation
C) straight-line depreciation; expensing investments
D) accelerated depreciation; straight-line depreciation

Question 37

The vast majority of large corporations face which tax rate?

A) 5%
B) 10%
C) 25%
D) 35%

Question 38

A positive effective corporate tax rate means that the corporation invests _____ with taxes,deductions,and investment tax credits than it would without them.A negative effective corporate tax rate means that the corporation invests _____ with taxes,deductions,and investment tax credits than it would without them.

A) more; more
B) more; less
C) less; more
D) the same amount; less

Question 39

What is the effective corporate tax rate when the value of the tax credit for each dollar of investment is $0,the tax rate on earnings is 35%,and investments are expensed?

A) -50%
B) 0%
C) 22.75%
D) 35%

Question 40

A tax system in which corporations are taxed by their home countries on their income regardless of where it is earned is called a ________ tax system.The United States uses a _______ tax system.

A) territorial; territorial
B) territorial; global
C) global; territorial
D) global; global

Question 41

Suppose that you are a bank executive and that two corporations have asked the bank,through you,to buy bonds to finance the respective investments that they'd like to make.The first firm is financed 90% through debt and 10% through equity,while the second firm is financed 50% through debt and 50% through equity.Except for the finance structure and its implications (if any),assume that there are no differences between the two firms.
(a)Suppose that you are unable to determine whether the project the first firm wants you to finance is any better or worse than the project the second firm wants you to finance.Suppose also that you want to lend both corporations the money.Should you charge both of them the same interest rate? Explain.
(b)Suppose that you were instead a firm manager.In which of the corporations would you rather be? Explain.

Question 42

How are tax payments made by U.S.-based corporations to foreign governments treated under U.S.corporate tax policy? Is there a tax advantage to corporations in earning income in other nations? Explain.

Question 43

Imagine a world in which there is no personal income tax,dividend tax,or capital gains tax.However,there is a significant corporate income tax.A firm wants to finance a new investment,and you'd like to be the investor.How would you like the corporation to finance the investment? Explain.

Question 44

Why don't companies finance all of their investment with debt and thereby avoid corporate taxation?