Question 1

Assume that Lucas'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 an 8 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?

Accepted Answer

Lucas's after-tax return on dividends is (1 - 0.15) = 0.85 times the dividend yield. Therefore, his after-tax dividend yield is 0.85 × 8% = 6.8%. Lucas's after-tax return on a municipal bond paying an interest rate of "i" is (1 - 0.32) = 0.68 times "i." Therefore, the equation to solve for "i" is:
0.68i = 6.8
i = 10%
Therefore, a municipal bond would have to offer a 10% interest rate for Lucas to be indifferent between the two investments from a cash-flow perspective. Since no answer choices are exactly 10%, the closest answer is D, 6.80%.

Question 2

Assume that Keisha's marginal tax rate is 37 percent and her tax rate on dividends is 15 percent. If a city of Atlanta bond pays 7.65 percent 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?

Accepted Answer

The answer of Assume that Keisha's marginal tax rate is...

Question 3

A common income-shifting strategy is to:

Accepted Answer

The answer of A common income-shifting strategy is to:
...

Question 4

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

Accepted Answer

The substance-over-form doctrine is likely violated here because the IRS could argue that the payment to the 10-year-old daughter for consulting does not reflect the economic reality of the transaction and is instead a means to shift income and reduce the taxpayer's tax liability. This doctrine allows the IRS to reclassify transactions based on their substance rather than their form.

Question 5

Assume that Bill's marginal tax rate is 32 percent. If corporate bonds pay 8 percent interest, what interest rate would a municipal bond have to offer for Bill to be indifferent between the two bonds?

Accepted Answer

To find the equivalent interest rate of a municipal bond that would make Bill indifferent, we use the formula for the after-tax return of the corporate bond and set it equal to the return of the municipal bond (since municipal bond interest is generally exempt from federal taxes). The formula for the after-tax return of the corporate bond is: Corporate Bond Interest Rate * (1 - Marginal Tax Rate). Plugging in the numbers: 8% * (1 - 0.32) = 5.44%. Therefore, a municipal bond would need to offer a 5.44% interest rate for Bill to be indifferent. Since this option is not listed, the correct choice is E) None of the choices are correct.

Question 6

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?

Accepted Answer

The assignment of income doctrine states that income must be taxed to the person who earned it or created it. In this case, the taxpayer instructing her son to collect rent checks and report them as taxable income on the son's tax return violates the assignment of income doctrine because the income from the property belongs to the taxpayer, not the son.

Question 7

Which of the following may limit the conversion strategy?

Accepted Answer

The answer of Which of the following may limit the...

Question 8

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

Accepted Answer

None of the listed doctrines limit the income-shifting strategy.

Question 9

Assume that John's marginal tax rate is 37 percent. If a city of Austin bond pays 6 percent interest, what interest rate would a corporate bond have to offer for John to be indifferent between the two bonds?

Accepted Answer

The formula for calculating the equivalent taxable yield for a tax-free bond is:

Equivalent Taxable Yield = Tax-free yield / (1 - Marginal tax rate)

Plugging in the given values, we get:

Equivalent Taxable Yield = 0.06 / (1 - 0.37) 
= 0.06 / 0.63 
= 0.0952 or 9.52%

Therefore, a corporate bond would have to offer a yield of 9.52% for John to be indifferent between the two bonds.

Question 10

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

Accepted Answer

The answer of Assume that Marsha is indifferent between investing...

Question 11

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?

Accepted Answer

The answer of Assume that Larry's marginal tax rate is...

Question 12

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, 2018, and has his daughter, Julie, pick up his check on January 2, 2019. Who reports the income and when?

Accepted Answer

The answer of Jason's employer pays year-end bonuses each year...

Question 13

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

Accepted Answer

Timing strategy involves managing the timing of income and expenses in order to minimize taxes. Option A describes a taxpayer paying all outstanding bills by year-end, which is a common timing strategy used to accelerate deductions into the current tax year. Options B, C, and D are not examples of timing strategies.

Question 14

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

Accepted Answer

The assignment of income doctrine states that income cannot be assigned to another person or entity to avoid taxes. In option B, the parent employing her child in the family business may be considered as an attempt to shift income from the parent to the child, and thus may receive IRS scrutiny. Option A is a legitimate dividend payment and is not an attempt to shift income. Option C is a gift and does not involve assignment of income. Option D is a timing strategy and does not involve assignment of income. Therefore, option B is the best choice.

Question 15

Assume that Lavonia's marginal tax rate is 22 percent. If a city of Tampa bond pays 5 percent interest, what interest rate would a corporate bond have to offer for Lavonia to be indifferent between the two bonds?

Accepted Answer

To find the equivalent taxable interest rate that would make Lavonia indifferent between a tax-exempt bond (like a municipal bond from the city of Tampa) and a taxable bond (like a corporate bond), we use the formula: Taxable Interest Rate = Tax-Exempt Interest Rate / (1 - Marginal Tax Rate). Plugging in Lavonia's details: 5% / (1 - 0.22) = 5% / 0.78 ≈ 6.41%. Since none of the provided options matches this calculation, the correct answer is E) None of the choices are correct.

Question 16

Which of the following is an example of the income-shifting strategy?

Accepted Answer

Paying the owner a salary is an income-shifting strategy because it allows the corporation to deduct the salary as an expense, reducing its taxable income, while the owner will pay taxes on their individual income tax return at a potentially lower tax rate. Dividends (choice A) are also a form of income shifting, but they are taxed at a higher rate than salaries. Investing in tax-exempt municipal bonds (choice C) is a tax avoidance strategy, not necessarily an income-shifting strategy. Delaying billing customers (choice D) is a timing strategy, not an income-shifting strategy.

Question 17

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

Accepted Answer

The income-shifting strategy involves transferring income from a taxpayer with a higher tax rate to one with a lower tax rate. Therefore, it requires taxpayers with varying tax rates.

Question 18

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

Accepted Answer

The conversion strategy involves converting taxable income into tax-exempt income. Option C is an example of this, as the high tax rate taxpayer is investing in tax-exempt municipal bonds to reduce their taxable income. Options A and B are not examples of the conversion strategy, as they involve paying out income rather than converting it. Option D is an example of income deferral, not conversion.

Question 19

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

Accepted Answer

The answer of Assume that Javier is indifferent between investing...

Question 20

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

Accepted Answer

The cash-basis business delaying billing its customers until after year-end is an example of a timing strategy, as it can help the business defer income taxes to the following year.

Quiz 3: Tax Planning Strategies and Related Limitations

A common income-shifting strategy is to:

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

Assume that Bill's marginal tax rate is 32 percent. If corporate bonds pay 8 percent interest, what interest rate would a municipal bond have to offer for Bill to be indifferent between the two bonds?

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?

Which of the following may limit the conversion strategy?

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

Assume that John's marginal tax rate is 37 percent. If a city of Austin bond pays 6 percent interest, what interest rate would a corporate bond have to offer for John to be indifferent between the two bonds?

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

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?

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

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

Assume that Lavonia's marginal tax rate is 22 percent. If a city of Tampa bond pays 5 percent interest, what interest rate would a corporate bond have to offer for Lavonia to be indifferent between the two bonds?

Which of the following is an example of the income-shifting strategy?

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

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

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

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