Exam 4: Maxims of Income Tax Planning

Understal Company has $750,000 to invest and two competing investment opportunities. Investment 1 would pay 9% per year ($67,500 annual before-tax cash flow). Investment 2 would pay 7% per year ($52,500 annual before-tax cash flow). The return on Investment 1 is taxable at Understal's 35% rate on ordinary income, while the return on Investment 2 is taxable at a 20% preferential rate. A. Compute the explicit and implicit tax that Understal would pay with respect to each investment. A. Understal would pay $23,625 explicit tax ($67,500 * 35%) and no implicit tax on Investment 1. It would pay $10,500 explicit tax ($52,500 * 20%) and $15,000 implicit tax (reduction in before-tax yield) on Investment 2. B. Investment 1 results in $43,875 after-tax cash flow, while Investment 2 results in $42,000 after-tax cash flow. B. Which investment results in the greater after-tax cash flow?

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

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

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

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

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

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?

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:

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

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.

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.

Which of the following statements about tax deferral is true?

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

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.

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?

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

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?

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

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