Exam 4: Maxims of Income Tax Planning

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?

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

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?

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

Gregly Company, which has a 33% marginal tax rate, plans to make an investment that should generate $300,000 annual cash flow/ordinary income. Instead of making the investment directly, Gregly could form a new taxable entity (L'il Greg) to make the investment. L'il Greg's marginal tax rate on the investment income would be only 25%. However, L'il Greg would have to incur a $26,500 annual nondeductible expense associated with the investment that Gregly would not incur. A. Gregly's annual after-tax cash flow if it made the investment directly would be $201,000 ($300,000 taxable income - $99,000 tax cost). L'il Greg's annual after-tax cash flow would be $198,500 ($300,000 taxable income - $75,000 tax cost - $26,500 nondeductible expense.) Therefore, Gregly should make the investment directly. A. Should Gregly make the investment directly or make it through L'il Greg to maximize after-tax cash flow? B. L'il Greg's annual after-tax cash flow would be $205,125 ($300,000 - $26,500 deductible expense - $68,375 tax cost [$273,500 taxable income * 25%]). Therefore, Gregly should make the investment through L'il Greg. B.. Would your answer change if L'il Greg could deduct its $26,500 additional expense?

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

The assignment of income doctrine holds that:

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.

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

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

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:

Assume that Congress recently amended the tax law to provide for a maximum 12% rate on interest income from U.S. savings bonds. Compute the tax savings from this preferential rate for: A. Mrs. Edwin saved $8.70 ($290 * [15% ordinary rate - 12% preferential rate]). A. Mrs. Edwin, who has a 15% marginal rate on ordinary income and earned $290 interest on her investment in U.S. savings bonds. B. Mr. Kalter saved $66.70 ($290 * [35% ordinary rate - 12% preferential rate]). B. Mr. Kalter, who has a 35% marginal rate on ordinary income and earned $290 interest on his investment in U.S. savings bonds.

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

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:

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

Tax evasion is a federal crime punishable by imprisonment.

Which of the following statements about tax strategies is false?

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

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(n):