University of Texas COURSE ACC 355, Spring 2014 -Chapter 3 Tax Planning Strategies and Related Limitations (PROBLEMS)

Problems
(1)
[LO2 PLANNING] Yong recently
paid his accountant $10,000 for elaborate tax planning strategies that exploit
the timing strategy. Assuming this is an
election year and there could be a power shift in the White House and Congress,
what is a potential risk associated with Yong’s strategies?

(2)
[LO2, LO3 PLANNING] Billups, a
physician and cash-method taxpayer, is new to the concept of tax planning and
recently learned of the timing strategy.
To implement the timing strategy, Billups plans to establish a new
policy that allows all his clients to wait two years to pay their co-pays. Assume that Billups does not expect his
marginal tax rates to change. What is
wrong with his strategy?

(3)
[LO2, LO3 PLANNING] Tesha works
for a company that pays a year-end bonus in January of each year (instead of
December of the preceding year) to allow employees to defer the bonus
income. Assume Congress recently passed
tax legislation that decreases individual tax rates as of next year. Does this increase or decrease the benefits
of the bonus deferral this year? What if
Congress passed legislation that increased tax rates next year? Should Tesha ask the company to change its
policy this year? What additional
information do you need to answer this question?

(4)
[LO2, LO3 PLANNING] Isabel, a
calendar-year taxpayer, uses the cash method of accounting for her sole
proprietorship. In late December she
received a $20,000 bill from her accountant for consulting services related to
her small business. Isabel can pay the
$20,000 bill anytime before January 30 of next year without penalty. Assume her marginal tax rate is 40 percent
this year and next year, and that she can earn an after-tax rate of return of
12 percent on her investments. When
should she pay the $20,000 bill—this
year or next? (5)
[LO2, LO3 PLANNING] Using the
facts from the previous problem, how would your answer change if Isabel’s
after-tax rate of return were 8 percent?(6)
[LO2,LO3 PLANNING] Manny, a
calendar-year taxpayer, uses the cash method of accounting for his sole
proprietorship. In late December he
performed $20,000 of legal services for a client. Manny typically requires his clients to pay
his bills immediately upon receipt.
Assume Manny’s marginal tax rate is 40 percent this year and next year,
and that he can earn an after-tax rate of return of 12 percent on his
investments. Should Manny send his
client the bill in December or January?(7)
[LO2,LO3 PLANNING] Using the
facts from the previous problem, how would your answer change if Manny’s
after-tax rate of return were 8 percent?(8)
[LO2, LO3 PLANNING] Reese, a
calendar-year taxpayer, uses the cash method of accounting for her sole
proprietorship. In late December she
received a $20,000 bill from her accountant for consulting services related to
her small business. Reese can pay the
$20,000 bill any time before January 30 of next year without penalty. Assume Reese’s marginal tax rate is 30
percent this year and will be 40 percent next year, and that she can earn an
after-tax rate of return of 12 percent on her investments. When should she pay the $20,000 bill—this year or next?(9)
[LO2, LO3 PLANNING] Using the
facts from the previous problem, when should Reese pay the bill if she expects
her marginal tax rate to be 33 percent next year? 25 percent next year?(10)
[LO2, LO3 PLANNING] Hank, a
calendar-year taxpayer, uses the cash method of accounting for his sole
proprietorship. In late December he
performed $20,000 of legal services for a client. Hank typically requires his clients to pay
his bills immediately upon receipt.
Assume his marginal tax rate is 30 percent this year and will be 40
percent next year, and that he can earn an after-tax rate of return of 12
percent on his investments. Should Hank
send his client the bill in December or January? (11)
[LO2, LO3 PLANNING] Using the
facts from the previous problem, when should Hank send the bill if he expect
his marginal tax rate to be 33 percent next year? 25 percent next year?

(12)
[LO3] Geraldo recently won a
lottery and chose to receive $100,000 today instead of an equivalent amount in
ten years, computed using an 8 percent rate of return. Today, he learned that interest rates are
expected to increase in the future. Is
this good news for Geraldo given his decision?(13)
[LO3 PLANNING] Assume Rafael
can earn an 8 percent after-tax rate of return.
Would he prefer $1,000 today or $1,500 in five years?

(14)
[LO3 PLANNING] Assume Ellina
earns a 10 percent after-tax rate of return, and that she owes a friend
$1,200. Would she prefer to pay the
friend $1,200 today or $1,750 in four years?

(15)
[LO3 PLANNING] Jonah has the
choice of paying Rita $10,000 today or $40,000 in ten years. Assume Jonah can earn a 12 percent after-tax
rate of return. Which should he choose?

(16)
[LO3 PLANNING] Bob’s Lottery,
Inc., has decided to offer winners a choice of $100,000 in ten years or some
amount currently. Assume that Bob’s
Lottery, Inc., earns a 10 percent after-tax rate of return. What amount should Bob offer lottery winners
currently, in order for him to be indifferent between the two choices?

(17)
[LO4 PLANNING] Tawana owns and operates a sole
proprietorship and has a 40 percent marginal tax rate. She provides her son, Jonathon, $8,000 a year
for college expenses. Jonathon works as
a pizza delivery person every fall and has a marginal tax rate of 15
percent. a.
What could Tawana do to reduce
her family tax burden? b.
How much pretax income does it
currently take Tawana to generate the $8,000 after-taxes given to
Jonathon? c.
If Jonathon worked for his
mother’s sole proprietorship, what salary would she have to pay him to generate
$8,000 after taxes (ignoring any Social Security, Medicare, or self-employment
tax issues)? d.
How much money would this
strategy save?

(18)
[LO4 PLANNING] Moana is a
single taxpayer who operates a sole proprietorship. She expects her taxable income next year to
be $250,000, of which $200,000 is attributed to her sole proprietorship. Moana is contemplating incorporating her sole
proprietorship. Using the single
individual tax brackets and the corporate tax brackets, find out how much
current tax this strategy could save Moana (ignore any Social Security,
Medicare, or self-employment tax issues).
How much income should be left in the corporation?
(19)
[LO4 PLANNING] Orie and Jane,
husband and wife, operate a sole proprietorship. They expect their taxable income next year to
be $275,000, of which $125,000 is attributed to the sole proprietorship. Orie and Jane are contemplating incorporating
their sole proprietorship. Using the
married-joint tax brackets and the corporate tax brackets, find out how much
current tax this strategy could save Orie and Jane. How much income should be left in the
corporation?
(20)
[LO4 PLANNING] Hyundai is
considering opening a plant in two neighboring states. One state has a corporate tax rate of 10
percent. If operated in this state, the
plant is expected to generate $1,000,000 pretax profit. The other state has a corporate tax rate of 2
percent. If operated in this state, the
plant is expected to generate $930,000 of pretax profit. Which state should Hyundai choose? Why do you think the plant in the state with
a lower tax rate would produce a lower before-tax income? (21)
[LO4, LO6 PLANNING] Bendetta, a high-tax-rate
taxpayer, owns several rental properties and would like to shift some income to
her daughter, Jenine. Bendetta instructs
her tenants to send their rent checks to Jenine so Jenine can report the rental
income. Will this shift the income from
Bendetta to Jenine? Why or why not?

(22)
[LO4, LO6 PLANNING] Using the
facts in the previous problem, what are some ways that Bendetta could shift
some of the rental income to Jenine?
What are the disadvantages associated with these income-shifting
strategies?
(23)
[LO5 PLANNING] Daniel is considering selling
two stocks that have not fared well over recent years. A friend recently
informed Daniel that one of his stocks has a special designation, which allows
him to treat a loss up to $50,000 on this stock as an ordinary loss rather than
the typical capital loss. Daniel figures that he has a loss of $60,000 on each
stock. If Daniel’s marginal tax rate is 35 percent and he has $120,000 of other
capital gains (taxed at 15 percent), what is the tax savings from the special
tax treatment?(24)
[LO5 PLANNING] Dennis is
currently considering investing in municipal bonds that earn 6 percent
interest, or in taxable bonds issued by the Coca-Cola Company that pay 8
percent. If Dennis’ tax rate is 20
percent, which bond should he choose?
Which bond should he choose if his tax rate is 30 percent? At what tax rate would he be indifferent
between the bonds? What strategy is this
decision based upon?

(25)
[LO5 PLANNING] Helen holds 1,000 shares of
Fizbo Inc. stock that she purchased 11 months ago. The stock has done very well
and has appreciated $20/share since Helen bought the stock. When sold, the
stock will be taxed at capital gains rates (long-term rate is 15% and
short-term rate is the taxpayer’s marginal tax rate). If Helen’s marginal tax
rate is 35%, how much would she save by holding the stock an additional month
before selling? What might prevent Helen from waiting to sell?(26)
[LO7] Duff is really interested
in decreasing his tax liability, and by his very nature he is somewhat
aggressive. A friend of a friend told
him that cash transactions are more difficult for the IRS to identify and,
thus, tax. Duff is contemplating using
this “strategy” of not reporting cash collected in his business to minimize his
tax liability. Is this tax
planning? What are the risks with this
strategy?

(27)
[LO7] Using the facts from the
previous problem, how would your answer change if instead, Duff adopted the
cash method of accounting to allow him to better control the timing of his cash
receipts and disbursements?

(28)
[LO2, LO4, LO5 PLANNING, RESEARCH] Using an
available tax service or the Internet, identify three basic tax planning ideas
or tax tips suggested for year-end tax planning. Which basic tax strategy from this chapter
does each planning idea employ?
(29)
[LO7 RESEARCH] Jayanna, an
advertising consultant, is contemplating instructing some of her clients to pay
her in cash so that she does not have to report the income on her tax
return. Use an available tax service to
identify the three basic elements of tax evasion and penalties associated with
tax evasion. Write a memo to Jayanna
explaining tax evasion and the risks associated with her actions. (30)
[LO7 RESEARCH] Using the IRS
Web site (www.irs.gov/index.html), how large is the current estimated “tax gap” (i.e., the amount of
tax underpaid by taxpayers annually)?
What group of taxpayers represents the largest “contributors” to the tax
gap?