Complete Test Bank Ch4 Maxims of Income Tax Planning - Taxation Principles 23e Complete Test Bank by Sally Jones. DOCX document preview.
Principles of Taxation for Business and Investment Planning, 23e (Jones)
Chapter 4 Maxims of Income Tax Planning
1) The goal of tax planning is to reduce tax costs or increase tax savings as much as possible.
Explanation: The goal is to maximize NPV.
Difficulty: 1 Easy
Topic: Tax Avoidance - Not Evasion
Learning Objective: 04-01 Describe the difference between tax avoidance and tax evasion.
Accessibility: Keyboard Navigation
Type: Static
2) Tax avoidance is the reduction of a person's tax liability through illegal means.
Difficulty: 1 Easy
Topic: Tax Avoidance - Not Evasion
Learning Objective: 04-01 Describe the difference between tax avoidance and tax evasion.
Accessibility: Keyboard Navigation
Type: Static
3) Tax evasion is a federal crime punishable by imprisonment.
Difficulty: 1 Easy
Topic: Tax Avoidance - Not Evasion
Learning Objective: 04-01 Describe the difference between tax avoidance and tax evasion.
Accessibility: Keyboard Navigation
Type: Static
4) The tax law applies uniformly to every commercial transaction by every business entity.
Difficulty: 1 Easy
Topic: Developing Tax Planning Strategies
Learning Objective: 04-08 Summarize the four tax planning maxims.
Accessibility: Keyboard Navigation
Type: Static
5) Planning opportunities are created when the tax law applies differentially to alternative business transactions.
Difficulty: 1 Easy
Topic: Developing Tax Planning Strategies
Learning Objective: 04-08 Summarize the four tax planning maxims.
Accessibility: Keyboard Navigation
Type: Static
6) Corporations, LLCs, and partnerships are all taxable entities.
Difficulty: 1 Easy
Topic: The Entity Variable
Learning Objective: 04-02 Explain why an income shift or a deduction shift from one entity to another can affect after-tax cash flows.
Accessibility: Keyboard Navigation
Type: Static
7) In the United States, individuals and corporations are the two entities that pay tax on business income.
Difficulty: 1 Easy
Topic: The Entity Variable
Learning Objective: 04-02 Explain why an income shift or a deduction shift from one entity to another can affect after-tax cash flows.
Accessibility: Keyboard Navigation
Type: Static
8) The entity variable is important because the amount of taxable income generated by a business depends on the type of entity conducting the business.
Explanation: The entity variable is important because of the different tax rates that apply to different entities.
Difficulty: 2 Medium
Topic: The Entity Variable
Learning Objective: 04-02 Explain why an income shift or a deduction shift from one entity to another can affect after-tax cash flows.
Accessibility: Keyboard Navigation
Type: Static
9) Both the individual and the corporate federal income tax rates are progressive.
Explanation: For income earned after 2017, the corporate income tax is computed using a flat tax rate of 21 percent.
Difficulty: 1 Easy
Topic: The Entity Variable
Learning Objective: 04-02 Explain why an income shift or a deduction shift from one entity to another can affect after-tax cash flows.
Accessibility: Keyboard Navigation
Type: Static
10) 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.
Explanation: The after-tax value of a dollar of income to a high-tax entity is less than the after-tax value to a low-tax entity.
Difficulty: 2 Medium
Topic: The Entity Variable
Learning Objective: 04-02 Explain why an income shift or a deduction shift from one entity to another can affect after-tax cash flows.
Accessibility: Keyboard Navigation
Type: Static
11) 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.
Difficulty: 2 Medium
Topic: The Entity Variable
Learning Objective: 04-02 Explain why an income shift or a deduction shift from one entity to another can affect after-tax cash flows.
Accessibility: Keyboard Navigation
Type: Static
12) Income-shifting transactions occur more frequently between related parties than between unrelated parties.
Difficulty: 1 Easy
Topic: The Entity Variable
Learning Objective: 04-02 Explain why an income shift or a deduction shift from one entity to another can affect after-tax cash flows.
Accessibility: Keyboard Navigation
Type: Static
13) Deduction-shifting transactions usually occur between unrelated taxpayers.
Difficulty: 1 Easy
Topic: The Entity Variable
Learning Objective: 04-02 Explain why an income shift or a deduction shift from one entity to another can affect after-tax cash flows.
Accessibility: Keyboard Navigation
Type: Static
14) According to the assignment of income doctrine, income must be taxed to the person receiving the cash from an income-generating transaction.
Explanation: Income must be taxed to the person that renders the service or owns the capital with respect to which the income is paid. The receipt of cash is irrelevant.
Difficulty: 2 Medium
Topic: Assignment of Income Doctrine
Learning Objective: 04-03 Explain how the assignment of income doctrine constrains income-shifting strategies.
Accessibility: Keyboard Navigation
Type: Static
15) The assignment of income doctrine constrains tax deferral strategies.
Explanation: The doctrine constrains income-shifting strategies.
Difficulty: 2 Medium
Topic: Assignment of Income Doctrine
Learning Objective: 04-03 Explain how the assignment of income doctrine constrains income-shifting strategies.
Accessibility: Keyboard Navigation
Type: Static
16) Andrea Mitchell can shift income to her daughter, Lynn, by endorsing a check for $10,000 received for a client over to Lynn.
Difficulty: 1 Easy
Topic: Assignment of Income Doctrine
Learning Objective: 04-03 Explain how the assignment of income doctrine constrains income-shifting strategies.
Accessibility: Keyboard Navigation
Type: Static
17) The time period variable is based on the time value of money.
Difficulty: 1 Easy
Topic: The Time Period Variable; Income Deferral and Rate Changes
Learning Objective: 04-04 Determine the effect on after-tax cash flows of deferral of a tax cost.
Accessibility: Keyboard Navigation
Type: Static
18) 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.
Difficulty: 1 Easy
Topic: The Entity Variable; The Time Period Variable; Income Deferral and Rate Changes
Learning Objective: 04-02 Explain why an income shift or a deduction shift from one entity to another can affect after-tax cash flows.; 04-04 Determine the effect on after-tax cash flows of deferral of a tax cost.
Accessibility: Keyboard Navigation
Type: Static
19) A planning strategy that defers a tax cost without deferring the receipt of before-tax cash flows decreases the NPV of the transaction.
Explanation: The strategy increases the NPV of the transaction.
Difficulty: 2 Medium
Topic: The Time Period Variable; Income Deferral and Rate Changes
Learning Objective: 04-04 Determine the effect on after-tax cash flows of deferral of a tax cost.
Accessibility: Keyboard Navigation
Type: Static
20) Opportunity cost refers to the decrease in NPV from a deferral of the receipt of before-tax cash flows.
Difficulty: 2 Medium
Topic: The Time Period Variable; Income Deferral and Rate Changes
Learning Objective: 04-04 Determine the effect on after-tax cash flows of deferral of a tax cost.
Accessibility: Keyboard Navigation
Type: Static
21) The tax character of an item of income depends on how the income is reported on the firm's financial statements.
Explanation: Tax character is determined strictly by the tax law and has nothing to do with financial reporting.
Difficulty: 2 Medium
Topic: The Character Variable
Learning Objective: 04-06 Contrast the tax character of ordinary income, capital gain, and tax-exempt income.
Accessibility: Keyboard Navigation
Type: Static
22) The tax character of an item of income can change when Congress amends the tax law.
Difficulty: 1 Easy
Topic: The Character Variable
Learning Objective: 04-06 Contrast the tax character of ordinary income, capital gain, and tax-exempt income.
Accessibility: Keyboard Navigation
Type: Static
23) The rate at which an item of income is taxed depends on the tax character of the income.
Difficulty: 1 Easy
Topic: The Character Variable
Learning Objective: 04-06 Contrast the tax character of ordinary income, capital gain, and tax-exempt income.
Accessibility: Keyboard Navigation
Type: Static
24) The 15% preferential tax rate on capital gains has the same value to every individual taxpayer.
Explanation: The value of a preferential rate varies with each individual's marginal rate on ordinary income.
Difficulty: 2 Medium
Topic: The Character Variable
Learning Objective: 04-06 Contrast the tax character of ordinary income, capital gain, and tax-exempt income.
Accessibility: Keyboard Navigation
Type: Static
25) A taxpayer should prefer to pay a $100 implicit tax rather than a $100 explicit tax.
Explanation: A taxpayer is neutral with respect to paying an identical amount of implicit or explicit tax.
Difficulty: 2 Medium
Topic: Implicit Taxes
Learning Objective: 04-07 Distinguish between an explicit tax and an implicit tax.
Accessibility: Keyboard Navigation
Type: Static
26) A reduced market rate of return on a tax-favored investment is called an implicit tax.
Difficulty: 1 Easy
Topic: Implicit Taxes
Learning Objective: 04-07 Distinguish between an explicit tax and an implicit tax.
Accessibility: Keyboard Navigation
Type: Static
27) Municipal bond investments bear less implicit tax than investments in taxable corporate bonds.
Difficulty: 2 Medium
Topic: Implicit Taxes
Learning Objective: 04-07 Distinguish between an explicit tax and an implicit tax.
Accessibility: Keyboard Navigation
Type: Static
28) Tax planning strategies to enhance NPV must reflect all four tax planning maxims.
Explanation: Tax planning strategies to enhance NPV reflect at least one tax planning maxim.
Difficulty: 1 Easy
Topic: Developing Tax Planning Strategies
Learning Objective: 04-08 Summarize the four tax planning maxims.
Accessibility: Keyboard Navigation
Type: Static
29) 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.
Explanation: The sentence defines the step transaction doctrine.
Difficulty: 1 Easy
Topic: Tax Legal Doctrines
Learning Objective: 04-09 Describe the legal doctrines that the IRS uses to challenge tax planning strategies.
Accessibility: Keyboard Navigation
Type: Static
30) The substance over form doctrine allows the IRS to look through the legal formalities of a transaction to determine its true economic nature.
Difficulty: 1 Easy
Topic: Tax Legal Doctrines
Learning Objective: 04-09 Describe the legal doctrines that the IRS uses to challenge tax planning strategies.
Accessibility: Keyboard Navigation
Type: Static
31) 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.
Explanation: The goal of tax planning is NPV maximization.
Difficulty: 2 Medium
Topic: Tax Avoidance - Not Evasion
Learning Objective: 04-01 Describe the difference between tax avoidance and tax evasion.
Accessibility: Keyboard Navigation
Type: Static
32) 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.
Difficulty: 1 Easy
Topic: Tax Avoidance - Not Evasion
Learning Objective: 04-01 Describe the difference between tax avoidance and tax evasion.
Accessibility: Keyboard Navigation
Type: Static
33) 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
Difficulty: 1 Easy
Topic: Developing Tax Planning Strategies
Learning Objective: 04-08 Summarize the four tax planning maxims.
Accessibility: Keyboard Navigation
Type: Static
34) 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
Difficulty: 1 Easy
Topic: The Jurisdiction Variable
Learning Objective: 04-05 Discuss why the jurisdiction in which a business operates affects after-tax cash flows.
Accessibility: Keyboard Navigation
Type: Static
35) 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
Difficulty: 1 Easy
Topic: Developing Tax Planning Strategies
Learning Objective: 04-08 Summarize the four tax planning maxims.
Accessibility: Keyboard Navigation
Type: Static
36) 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
Difficulty: 1 Easy
Topic: Developing Tax Planning Strategies
Learning Objective: 04-08 Summarize the four tax planning maxims.
Accessibility: Keyboard Navigation
Type: Static
37) 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
Difficulty: 1 Easy
Topic: Developing Tax Planning Strategies
Learning Objective: 04-08 Summarize the four tax planning maxims.
Accessibility: Keyboard Navigation
Type: Static
38) 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
Difficulty: 1 Easy
Topic: The Jurisdiction Variable
Learning Objective: 04-05 Discuss why the jurisdiction in which a business operates affects after-tax cash flows.
Accessibility: Keyboard Navigation
Type: Static
39) 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
Difficulty: 2 Medium
Topic: Developing Tax Planning Strategies
Learning Objective: 04-08 Summarize the four tax planning maxims.
Accessibility: Keyboard Navigation
Type: Static
40) 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
Difficulty: 1 Easy
Topic: Developing Tax Planning Strategies
Learning Objective: 04-08 Summarize the four tax planning maxims.
Accessibility: Keyboard Navigation
Type: Static
41) 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
Explanation: The taxpayer will be taxed on any increase in the stock's value in the future year in which the taxpayer sells the stock. Taxpayers recognize dividend income in the year of receipt.
Difficulty: 3 Hard
Topic: Developing Tax Planning Strategies
Learning Objective: 04-08 Summarize the four tax planning maxims.
Accessibility: Keyboard Navigation
Type: Static
42) 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
Explanation: Gain on sale of a principal residence is taxed at a preferential rate because of the special tax character of the gain.
Difficulty: 3 Hard
Topic: Developing Tax Planning Strategies
Learning Objective: 04-08 Summarize the four tax planning maxims.
Accessibility: Keyboard Navigation
Type: Static
43) 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
Explanation: Mr. Dole is deferring the tax cost of the taxable gain on sale from 20Y1 to 20Y2.
Difficulty: 2 Medium
Topic: Developing Tax Planning Strategies
Learning Objective: 04-08 Summarize the four tax planning maxims.
Accessibility: Keyboard Navigation
Type: Static
44) 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.
Difficulty: 1 Easy
Topic: The Entity Variable; Income Shifting; Deduction Shifting
Learning Objective: 04-02 Explain why an income shift or a deduction shift from one entity to another can affect after-tax cash flows.
Accessibility: Keyboard Navigation
Type: Static
45) 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.
Explanation: The tax provisions governing the computation of business income are essentially neutral across organizational forms.
Difficulty: 2 Medium
Topic: The Entity Variable; Income Shifting; Deduction Shifting
Learning Objective: 04-02 Explain why an income shift or a deduction shift from one entity to another can affect after-tax cash flows.
Accessibility: Keyboard Navigation
Type: Static
46) 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.
Difficulty: 1 Easy
Topic: The Entity Variable; Income Shifting; Deduction Shifting
Learning Objective: 04-02 Explain why an income shift or a deduction shift from one entity to another can affect after-tax cash flows.
Accessibility: Keyboard Navigation
Type: Static
47) 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.
Difficulty: 2 Medium
Topic: The Entity Variable; Implicit Taxes; Income Shifting
Learning Objective: 04-02 Explain why an income shift or a deduction shift from one entity to another can affect after-tax cash flows.
Accessibility: Keyboard Navigation
Type: Static
48) 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 21%, and PTB's tax rate is 10%, compute the tax savings from the income shift.
A) $157,500
B) $75,000
C) $82,500
D) $78,750
Difficulty: 1 Easy
Topic: The Entity Variable; Income Shifting; Deduction Shifting
Learning Objective: 04-02 Explain why an income shift or a deduction shift from one entity to another can affect after-tax cash flows.
Accessibility: Keyboard Navigation
Type: Static
49) 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 12%, compute the tax savings from the income shift.
A) $0
B) $10,800
C) $31,500
D) None of the above
Explanation: The tax savings is $20,700 ($90,000 income × 23% difference in tax rates).
Difficulty: 1 Easy
Topic: The Entity Variable
Learning Objective: 04-02 Explain why an income shift or a deduction shift from one entity to another can affect after-tax cash flows.
Accessibility: Keyboard Navigation
Type: Static
50) 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.
Explanation: The entity variable is relevant in a tax system with a progressive rate structure, even if the rates apply to every type of income without regard to any special character of the income.
Difficulty: 3 Hard
Topic: The Entity Variable; Income Shifting; Deduction Shifting
Learning Objective: 04-02 Explain why an income shift or a deduction shift from one entity to another can affect after-tax cash flows.
Accessibility: Keyboard Navigation
Type: Static
51) 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.
Explanation: If Varson's marginal tax rate is higher than Vonsell's marginal tax rate, Varson should purchase the advertising to minimize after-tax cost. Varson cannot deduct the advertising unless it purchases it.
Difficulty: 3 Hard
Topic: The Entity Variable; Income Shifting; Deduction Shifting
Learning Objective: 04-02 Explain why an income shift or a deduction shift from one entity to another can affect after-tax cash flows.
Accessibility: Keyboard Navigation
Type: Static
52) Mrs. Bern's marginal tax rate is 35%, and her grandson Jeff's marginal tax rate is 12%. 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.
Difficulty: 2 Medium
Topic: Assignment of Income Doctrine
Learning Objective: 04-03 Explain how the assignment of income doctrine constrains income-shifting strategies.
Accessibility: Keyboard Navigation
Type: Static
53) Carter Inc. and CCC Inc. are owned by the same family. Carter's marginal tax rate is 21%, and CCC's marginal tax rate is 10%. 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 $16,750 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.
Explanation: Carter's after-tax cash flow would be $395,000 ($500,000 before-tax cash flow − $105,000 tax cost). CCC's after-tax cash flow would be $411,750 ($457,500 before-tax cash flow − $45,750 tax cost).
Difficulty: 3 Hard
Topic: Assignment of Income Doctrine
Learning Objective: 04-03 Explain how the assignment of income doctrine constrains income-shifting strategies.
Accessibility: Keyboard Navigation
Type: Static
54) OWB Inc. and Owin Inc. are owned by the same family. OWB's marginal tax rate is 30%, and Owin's marginal tax rate is 21%. 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 $24,900 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.
Explanation: OWB's after-tax cash flow would be $175,000 ($250,000 before-tax cash flow − $75,000 tax cost). Owin's after-tax cash flow would be $150,100 ($190,000 before-tax cash flow − $39,900 tax cost).
Difficulty: 3 Hard
Topic: Assignment of Income Doctrine
Learning Objective: 04-03 Explain how the assignment of income doctrine constrains income-shifting strategies.
Accessibility: Keyboard Navigation
Type: Static
55) 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.
Explanation: In statements A. and C., Mrs. Reid transferred ownership of the income-producing asset (capital), so the assignment of income doctrine does not apply.
Difficulty: 3 Hard
Topic: Assignment of Income Doctrine
Learning Objective: 04-03 Explain how the assignment of income doctrine constrains income-shifting strategies.
Accessibility: Keyboard Navigation
Type: Static
56) The assignment of income doctrine indicates 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
Difficulty: 1 Easy
Topic: Assignment of Income Doctrine
Learning Objective: 04-03 Explain how the assignment of income doctrine constrains income-shifting strategies.
Accessibility: Keyboard Navigation
Type: Static
57) 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.
Difficulty: 1 Easy
Topic: Assignment of Income Doctrine
Learning Objective: 04-03 Explain how the assignment of income doctrine constrains income-shifting strategies.
Accessibility: Keyboard Navigation
Type: Static
58) 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.
Difficulty: 1 Easy
Topic: The Time Period Variable; Income Deferral and Rate Changes
Learning Objective: 04-04 Determine the effect on after-tax cash flows of deferral of a tax cost.
Accessibility: Keyboard Navigation
Type: Static
59) 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
Difficulty: 1 Easy
Topic: The Time Period Variable; Income Deferral and Rate Changes
Learning Objective: 04-04 Determine the effect on after-tax cash flows of deferral of a tax cost.
Accessibility: Keyboard Navigation
Type: Static
60) 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.
Explanation: The value of tax deferral increases as the taxpayer's discount rate for computing NPV increases.
Difficulty: 2 Medium
Topic: The Time Period Variable; Income Deferral and Rate Changes
Learning Objective: 04-04 Determine the effect on after-tax cash flows of deferral of a tax cost.
Accessibility: Keyboard Navigation
Type: Static
61) 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.
Explanation: By accelerating the before-tax cash inflow and deferring the tax cost of the income, Jelk will maximize NPV.
Difficulty: 2 Medium
Topic: The Time Period Variable; Income Deferral and Rate Changes
Learning Objective: 04-04 Determine the effect on after-tax cash flows of deferral of a tax cost.
Accessibility: Keyboard Navigation
Type: Static
62) 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.
Explanation: By accelerating the tax savings from the deduction and deferring the before-tax cash outflow, NWR will minimize NPV.
Difficulty: 2 Medium
Topic: The Time Period Variable; Income Deferral and Rate Changes
Learning Objective: 04-04 Determine the effect on after-tax cash flows of deferral of a tax cost.
Accessibility: Keyboard Navigation
Type: Static
63) 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). Use Appendix A of your textbook provided to 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 21%, and it uses a 10% discount rate to compute NPV.
A) $2,558
B) $1,338
C) $9,622
D) None of the above
Explanation: NPV under the current structure is $55,300 ($70,000 before-tax cash inflow − $14,700 tax cost). If the tax cost is deferred two years, NPV is $57,858 ($70,000 − [$14,700 × 0.826]) for an increase of $2,558.
Difficulty: 2 Medium
Topic: The Time Period Variable; Income Deferral and Rate Changes
Learning Objective: 04-04 Determine the effect on after-tax cash flows of deferral of a tax cost.
Accessibility: Keyboard Navigation
Type: Static
64) 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). Use Appendix A of your textbook provided to 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 21%, and it uses a 9% discount rate to compute NPV.
A) $6,276
B) $17,938
C) $4,793
D) None of the above
Explanation: NPV under the current structure is $217,250 ($275,000 before-tax cash inflow − $57,750 tax cost). If the tax cost is deferred one year, NPV is $222,043 ($275,000 − [$57,750 × 0.917]) for an increase of $4,793.
Difficulty: 2 Medium
Topic: The Time Period Variable; Income Deferral and Rate Changes
Learning Objective: 04-04 Determine the effect on after-tax cash flows of deferral of a tax cost.
Accessibility: Keyboard Navigation
Type: Static
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). Use Appendix A of your textbook provided to 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 three years later (year 3). 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
Explanation: NPV under the current structure is ($45,000) (($60,000) before-tax cash outflow + $15,000 tax savings). If the cash outflow is deferred two years, NPV is ($35,520) ([($60,000) × 0.842] + $15,000) for an increase of $9,480.
Difficulty: 3 Hard
Topic: The Time Period Variable; Income Deferral and Rate Changes
Learning Objective: 04-04 Determine the effect on after-tax cash flows of deferral of a tax cost.
Accessibility: Keyboard Navigation
Type: Static
66) 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). Use Appendix A of your textbook provided to 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 21%, and it uses a 7% discount rate to compute NPV.
A) $15,928
B) $18,400
C) $21,516
D) None of the above
Explanation: NPV under the current structure is ($79,000) (($100,000) before-tax cash outflow + $21,000 tax savings). If the cash outflow is deferred three years, NPV is ($60,600) ([($100,000) × 0.816] + $21,000) for an increase of $18,400.
Difficulty: 3 Hard
Topic: The Time Period Variable; Income Deferral and Rate Changes
Learning Objective: 04-04 Determine the effect on after-tax cash flows of deferral of a tax cost.
Accessibility: Keyboard Navigation
Type: Static
67) 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. Use Appendix A of your textbook provided to determine 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.
Explanation: Transaction A's NPV is $300,000 ($500,000 before-tax cash flow − $200,000 tax cost). Transaction B's NPV is $292,744 ($460,000 before-tax cash flow − $167,256 discounted tax cost [$184,000 × 0.909]).
Difficulty: 3 Hard
Topic: The Time Period Variable; Income Deferral and Rate Changes
Learning Objective: 04-04 Determine the effect on after-tax cash flows of deferral of a tax cost.
Accessibility: Keyboard Navigation
Type: Static
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. Use Appendix A of your textbook provided to determine 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.
Explanation: Transaction A's NPV is $105,000 ($175,000 before-tax cash flow − $70,000 tax cost). Transaction B's NPV is $106,112 ($160,000 before-tax cash flow − $53,888 discounted tax cost [$64,000 × 0.842]).
Difficulty: 3 Hard
Topic: The Time Period Variable; Income Deferral and Rate Changes
Learning Objective: 04-04 Determine the effect on after-tax cash flows of deferral of a tax cost.
Accessibility: Keyboard Navigation
Type: Static
69) 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.
Difficulty: 1 Easy
Topic: The Time Period Variable; Income Deferral and Rate Changes; The Jurisdiction Variable
Learning Objective: 04-04 Determine the effect on after-tax cash flows of deferral of a tax cost.; 04-05 Discuss why the jurisdiction in which a business operates affects after-tax cash flows.
Accessibility: Keyboard Navigation
Type: Static
70) 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.
Difficulty: 1 Easy
Topic: The Character Variable
Learning Objective: 04-06 Contrast the tax character of ordinary income, capital gain, and tax-exempt income.
Accessibility: Keyboard Navigation
Type: Static
71) 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.
Explanation: Corporations do not have a preferential tax rate on capital gains.
Difficulty: 2 Medium
Topic: The Character Variable
Learning Objective: 04-06 Contrast the tax character of ordinary income, capital gain, and tax-exempt income.
Accessibility: Keyboard Navigation
Type: Static
72) 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 the same rate as ordinary income.
C) Corporations pay tax on both ordinary income at their regular rate and capital gain at their regular a preferential 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.
Difficulty: 2 Medium
Topic: The Character Variable
Learning Objective: 04-06 Contrast the tax character of ordinary income, capital gain, and tax-exempt income.
Accessibility: Keyboard Navigation
Type: Static
73) 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 22%, she can elect to recharacterize the capital gain as ordinary income.
B) If Mrs. Stout's regular marginal tax rate is 24%, 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.
Explanation: Taxpayers cannot elect to characterize income as ordinary or capital. The characterization is based on statutory law.
Difficulty: 2 Medium
Topic: The Character Variable
Learning Objective: 04-06 Contrast the tax character of ordinary income, capital gain, and tax-exempt income.
Accessibility: Keyboard Navigation
Type: Static
74) 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.
Explanation: The return on investment 1 is 6.5% (10% * [1 − 35%]). The return on investment 2 is 6.8% (8% * [1 − 15%]).
Difficulty: 3 Hard
Topic: The Character Variable
Learning Objective: 04-06 Contrast the tax character of ordinary income, capital gain, and tax-exempt income.
Accessibility: Keyboard Navigation
Type: Static
75) 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' 24% 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.
Explanation: The after-tax yield on investment 1 is 6.84% (9.0% × [1 − 0.24 tax rate]). The after-tax yield on investment 2 is 6.375% (7.5% × [1 − 0.15 tax rate]). The after-tax yield on investment 3 is 6.0%.
Difficulty: 2 Medium
Topic: Implicit Taxes
Learning Objective: 04-07 Distinguish between an explicit tax and an implicit tax.
Accessibility: Keyboard Navigation
Type: Static
76) 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 32% 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.
Explanation: The after-tax yield on investment 1 is 5.78% (8.5% × [1 − 0.32 tax rate]). The after-tax yield on investment 2 is 6.375% (7.5% × [1 − 0.15 tax rate]). The after-tax yield on investment 3 is 6.0%.
Difficulty: 2 Medium
Topic: Implicit Taxes
Learning Objective: 04-07 Distinguish between an explicit tax and an implicit tax.
Accessibility: Keyboard Navigation
Type: Static
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 37% 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.
Explanation: The after-tax yield on investment 1 is 5.198% (8.25% × [1 − 0.37 tax rate]). The after-tax yield on investment 2 is 6.0% (7.5% × [1 − 0.20 tax rate]). The after-tax yield on investment 3 is also 6.0%.
Difficulty: 2 Medium
Topic: Implicit Taxes
Learning Objective: 04-07 Distinguish between an explicit tax and an implicit tax.
Accessibility: Keyboard Navigation
Type: Static
78) Mr. Fox has $100,000 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 $2,000 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 37%, he should invest in the tax-exempt bonds.
D) None of the above is false.
Explanation: If Mr. Fox's marginal tax rate is 15%, he should invest in the corporate bonds, Mr. Fox's explicit tax is $1,500, which is less than the $2,000 implicit tax on the yield from the tax-exempt bonds. Therefore, he should invest in the taxable bonds. If Mr. Fox's marginal tax rate is 37%, he should invest in the tax-exempt bonds, Mr. Fox's explicit tax is $3,700, which is more than the $2,000 implicit tax. Therefore, he should invest in the tax-exempt bonds.
Difficulty: 3 Hard
Topic: Implicit Taxes
Learning Objective: 04-07 Distinguish between an explicit tax and an implicit tax.
Accessibility: Keyboard Navigation
Type: Static
79) 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
Difficulty: 1 Easy
Topic: Implicit Taxes
Learning Objective: 04-07 Distinguish between an explicit tax and an implicit tax.
Accessibility: Keyboard Navigation
Type: Static
80) 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.
Explanation: An implicit tax is a reduced before-tax rate of return on a tax-favored investment. The implicit tax is determined by the market and is independent of any one investor's marginal tax rate.
Difficulty: 2 Medium
Topic: Implicit Taxes
Learning Objective: 04-07 Distinguish between an explicit tax and an implicit tax.
Accessibility: Keyboard Navigation
Type: Static
81) Which of the following statements about implicit and explicit taxes is false?
A) The taxpayer pays an explicit tax to the taxing jurisdiction.
B) An investment yielding ordinary income taxed at the regular tax rates should not have an implicit tax.
C) Any implicit tax on investment income is always more than the explicit tax on the income.
D) An implicit tax reduces the before-tax yield on an investment.
Explanation: An implicit tax can be more or less than an explicit tax on the same income.
Difficulty: 2 Medium
Topic: Implicit Taxes
Learning Objective: 04-07 Distinguish between an explicit tax and an implicit tax.
Accessibility: Keyboard Navigation
Type: Static
82) Which of the following statements about tax strategies is false?
A) Tax planners should prefer a simple strategy over a complex strategy.
B) Tax planners should prefer a flexible strategy over an inflexible strategy.
C) Tax planners should consider the tax consequences of a strategy to all parties.
D) None of the above is false.
Difficulty: 1 Easy
Topic: Developing Tax Planning Strategies
Learning Objective: 04-08 Summarize the four tax planning maxims.
Accessibility: Keyboard Navigation
Type: Static
83) Which of the following statements about tax legal doctrines is false?
A) The scope of the economic substance, business purpose, substance over form, and step transaction doctrines often overlap.
B) Taxpayers can invoke the substance over form doctrine to undo the tax consequences of a failed planning strategy.
C) The IRS's application of the doctrines is subjective.
D) The economic substance, business purpose, substance over form, and step transaction doctrines increase the uncertainty of the tax law.
Difficulty: 1 Easy
Topic: Tax Legal Doctrines
Learning Objective: 04-09 Describe the legal doctrines that the IRS uses to challenge tax planning strategies.
Accessibility: Keyboard Navigation
Type: Static
84) Mr. Coomb structured a transfer of real estate to his daughter as a sale. Upon audit, the IRS agent analyzed the economic consequences of the transfer and treated it as a gift by applying the:
A) Business purpose doctrine
B) Substance over form doctrine
C) Assignment of income doctrine
D) Step transaction doctrine
Difficulty: 1 Easy
Topic: Tax Legal Doctrines
Learning Objective: 04-09 Describe the legal doctrines that the IRS uses to challenge tax planning strategies.
Accessibility: Keyboard Navigation
Type: Static
85) Mr. Bearne paid $50,000 to a local spiritual healer and deducted the payment as a business expense of his sole proprietorship. The healer provided personal counseling to Mr. and Mrs. Bearne. Upon audit of the sole proprietorship's accounting records, the IRS agent disallowed the deduction by applying the:
A) Business purpose doctrine
B) Assignment of income doctrine
C) Economic substance doctrine
D) Constructive payment doctrine
Difficulty: 1 Easy
Topic: Tax Legal Doctrines
Learning Objective: 04-09 Describe the legal doctrines that the IRS uses to challenge tax planning strategies.
Accessibility: Keyboard Navigation
Type: Static
86) Nilo Inc. sold an asset to PPQ Partnership, which is unrelated to Nilo. PPQ immediately sold the property to Nilo Western Inc., which is a 100% controlled Nilo subsidiary. The IRS could treat the two sales as one sale of the asset by Nilo to Nilo Western by applying the:
A) Economic substance doctrine
B) Assignment of income doctrine
C) Step transaction doctrine
D) Constructive payment doctrine
Difficulty: 1 Easy
Topic: Tax Legal Doctrines
Learning Objective: 04-09 Describe the legal doctrines that the IRS uses to challenge tax planning strategies.
Accessibility: Keyboard Navigation
Type: Static
87) In 20Y1, Ms. Graves transferred appreciated property to KL Partnership in exchange for an ownership interest in the partnership. She deliberately waited until 20Y3 before taking cash out of the partnership. Ms. Graves may have been trying to prevent the IRS from applying the:
A) Business purpose doctrine
B) Economic substance doctrine
C) Substance over form doctrine
D) Step transaction doctrine
Difficulty: 2 Medium
Topic: Tax Legal Doctrines
Learning Objective: 04-09 Describe the legal doctrines that the IRS uses to challenge tax planning strategies.
Accessibility: Keyboard Navigation
Type: Static
88) Tatun Inc. pays state income tax at a 5% rate and federal income tax at a 21% rate. Tatun recently engaged in a transaction in Mexico, which levied a $25,200 income tax on the transaction. Tatun's pretax net income for the current year is $1,913,900. Compute Tatun's total income tax burden assuming that:
A. The Mexican tax is nondeductible for state and federal tax purposes.
B. The Mexican tax is deductible for state and federal tax purposes.
A. Tatun's state tax is $95,695 ($1,913,900 × 5%), and its federal tax is $381,823 ([$1,913,900 − $95,695 deduction for state tax] × 21%). Tatun's total income tax burden is $502,718 ($95,695 state tax + $381,823 federal tax + $25,200 Mexican tax).
B. Tatun's state tax is $94,435 ([$1,913,900 − $25,200 deduction for Mexican tax] × 5%), and its federal tax is $376,796 ([$1,913,900 − $94,435 deduction for state tax − $25,200 deduction for Mexican tax] × 21%). Tatun's total income tax burden is $496,431 ($94,435 state tax + $376,796 federal tax + $25,200 Mexican tax).
Difficulty: 2 Medium
Topic: Developing Tax Planning Strategies
Learning Objective: 04-08 Summarize the four tax planning maxims.
Accessibility: Keyboard Navigation
Type: Static
89) 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, who has a 15% marginal rate on ordinary income and earned $290 interest on her investment in U.S. savings bonds.
B. Mr. Kalter, who has a 35% marginal rate on ordinary income and earned $290 interest on his investment in U.S. savings bonds.
A. Mrs. Edwin saved $8.70 ($290 × [15% ordinary rate − 12% preferential rate]).
B. Mr. Kalter saved $66.70 ($290 × [35% ordinary rate − 12% preferential rate]).
Difficulty: 1 Easy
Topic: The Character Variable
Learning Objective: 04-06 Contrast the tax character of ordinary income, capital gain, and tax-exempt income.
Accessibility: Keyboard Navigation
Type: Static
90) 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.
B. Which investment results in the greater after-tax cash flow?
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.
Difficulty: 2 Medium
Topic: Implicit Taxes
Learning Objective: 04-07 Distinguish between an explicit tax and an implicit tax.
Accessibility: Keyboard Navigation
Type: Static
91) Gregly Company, which has a 21% 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 13%. However, L'il Greg would have to incur a $26,500 annual nondeductible expense associated with the investment that Gregly would not incur.
A. Should Gregly make the investment directly or make it through L'il Greg to maximize after-tax cash flow?
B. Would your answer change if L'il Greg could deduct its $26,500 additional expense?
A. Gregly's annual after-tax cash flow if it made the investment directly would be $237,000 ($300,000 taxable income − $63,000 tax cost). L'il Greg's annual after-tax cash flow would be $234,500 ($300,000 taxable income − $39,000 tax cost − $26,500 nondeductible expense.) Therefore, Gregly should make the investment directly.
B. L'il Greg's annual after-tax cash flow would be $237,945 ($300,000 − $26,500 deductible expense − $41,025 tax cost [$273,500 taxable income × 13%]). Therefore, Gregly should make the investment through L'il Greg.
Difficulty: 3 Hard
Topic: The Entity Variable
Learning Objective: 04-02 Explain why an income shift or a deduction shift from one entity to another can affect after-tax cash flows.
Accessibility: Keyboard Navigation
Type: Static
92) Elton Company plans to build a new facility to manufacture backpacks. Elton sells its backpacks across the country for $300 per pack. It could locate the plan in state A, which levies a 5 percent tax on business income. The estimated manufacturing cost per pack in state A would be $120. Alternatively, Elton could locate the plan in state B, which levies a 3 percent tax on business income. The estimated manufacturing cost in state B is $126 per pack. In which state should Elton locate its plant? Provide calculations to support your conclusion.
Difficulty: 3 Hard
Topic: Developing Tax Planning Strategies; The Jurisdiction Variable
Learning Objective: 04-08 Summarize the four tax planning maxims.; 04-05 Discuss why the jurisdiction in which a business operates affects after-tax cash flows.
Accessibility: Keyboard Navigation
Type: Static