McGraw-Hill’s Essentials of Federal Taxation 2020 Edition By Brian Spilker – Test Bank
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Essentials of Federal Taxation, 11e (Spilker)
Chapter 3 Tax Planning Strategies and Related
Limitations
1) The goal of tax planning is tax minimization.
2) Nontax factors do not play an important role in tax planning.
3) Virtually every transaction involves the taxpayer and two
other parties that have an interest in the tax ramifications of the
transaction.
4) The timing strategy is based on the idea that the location of
where the income is taxed affects the tax costs of the income.
5) In general, tax planners prefer to accelerate deductions.
6) The concept of present value is an important part of the
timing strategy.
7) Assuming an after-tax rate of return of 10 percent, John
should prefer to pay an expense of $85 today instead of an expense of $100 in
one year. Use Exhibit 3.1.
8) The time value of money suggests that $1 one year from now is
worth less than $1 today.
9) The present value concept becomes more important as interest
rates increase.
10) Future value can be computed as Future Value = Present
Value/(1 + r)n.
11) When considering cash inflows, higher present values are
preferred.
12) When considering cash outflows, higher present values are
preferred.
13) Tax savings generated from deductions are considered cash
inflows.
14) In general, tax planners prefer to defer income. This is an
example of the conversion strategy.
15) The timing strategy is particularly effective for cash-basis
taxpayers.
16) The timing strategy becomes more attractive as tax rates
decrease.
17) The timing strategy becomes more attractive as interest
rates (i.e., rates of return) increase.
18) The timing strategy becomes more attractive if a taxpayer is
able to accelerate deductions by two or more years (versus one year).
19) One limitation of the timing strategy is the difficulties in
accelerating a tax deduction without accelerating the actual cash outflow that
generates the tax deduction.
20) The constructive receipt doctrine is a natural limitation
for the conversion strategy.
21) The constructive receipt doctrine is more of an issue for
cash-basis taxpayers.
22) If tax rates will be higher next year, taxpayers should
accelerate their deductions regardless of their after-tax rate of return.
23) If tax rates will be lower next year, taxpayers should
accelerate their deductions regardless of their after-tax rate of return.
24) If tax rates will be higher next year, taxpayers should
defer their income to next year regardless of their after-tax rate of return.
25) The value of a tax deduction is higher for a taxpayer with a
lower tax rate.
26) The income-shifting strategy requires taxpayers with varying
tax rates.
27) The assignment of income doctrine is a natural limitation to
the timing strategy.
28) The business purpose, step-transaction, and
substance-over-form doctrines may limit the income-shifting strategy.
29) Paying dividends to shareholders is one effective way of
shifting income from a corporation to its shareholders.
30) The conversion strategy capitalizes on the fact that tax
rates vary across different activities.
31) An investment’s time horizon does not affect after-tax rates
of return on investments taxed annually.
32) Implicit taxes may reduce the benefits of the conversion
strategy.
33) Investors must consider complicit taxes as well as explicit
taxes in order to make correct investment choices.
34) The business purpose, step-transaction, and
substance-over-form doctrines may limit the conversion strategy.
35) Tax avoidance is a legal activity that forms the basis of
the basic tax planning strategies.
36) Tax evasion is a legal activity that forms the basis of the
basic tax planning strategies.
37) The downside of tax avoidance includes the potential of
stiff monetary penalties and imprisonment.
38) The goal of tax planning generally is to:
1. A)
minimize taxes.
2. B)
minimize IRS scrutiny.
3. C)
maximize after-tax wealth.
4. D)
support the federal government.
5. E)
None of the choices are correct.
39) Effective tax planning requires all of these considerations
except:
1. A)
nontax factors.
2. B)
the taxpayer’s tax costs of alternative transactions.
3. C)
the other party’s tax costs of alternative transactions.
4. D)
the other party’s nontax costs of alternative transactions.
5. E)
all of the choices are required considerations.
40) Which is not a basic tax planning strategy?
1. A)
Income shifting.
2. B)
Timing.
3. C)
Conversion.
4. D)
Arm’s length transaction.
5. E)
None of the choices are correct.
41) Which of the following tax planning strategies is based on
the present value of money?
1. A)
timing.
2. B)
tax avoidance.
3. C)
income shifting.
4. D)
conversion.
5. E)
None of the choices are correct.
42) Assuming a positive interest rate, the present value of
money suggests:
1. A) $1
today = $1 in one year.
2. B) $1
today > $1 in one year.
3. C) $1
today < $1 in one year.
4. D) $1
today ≤ $1 in one year.
5. E)
None of the choices are correct.
43) If Joel earns a 10 percent after-tax rate of return, $10,000
received in two years is worth how much today? Use Exhibit 3.1. (Round discount factor(s) to three
decimal places.)
1. A)
$10,000.
2. B)
$9,090.
3. C)
$8,260.
4. D)
$11,000.
5. E)
None of the choices are correct.
44) If Lucy earns a 6 percent after-tax rate of return, $8,000
received in four years is worth how much today? Use Exhibit 3.1. (Round discount factor(s) to three
decimal places.)
1. A)
$8,000.
2. B)
$7,544.
3. C)
$8,989.
4. D)
$6,336.
5. E)
None of the choices are correct.
45) If Nicolai earns an 8 percent after-tax rate of return,
$20,000 today would be worth how much to Nicolai in five years? Use future
value of $1. (Round
discount factor(s) to four decimal places.)
1. A)
$20,000.
2. B)
$13,620.
3. C)
$18,520.
4. D)
$21,600.
5. E)
None of the choices are correct.
46) If Scott earns a 12 percent after-tax rate of return,
$15,000 today would be worth how much to Scott in two years? Usefuture value of
$1. (Round
discount factor(s) to five decimal places.)
1. A)
$15,000.
2. B) $11,955.
3. C)
$18,520.
4. D)
$18,816.
5. E)
None of the choices are correct.
47) If Rudy has a 25 percent tax rate and a 6 percent after-tax
rate of return, a $30,000 tax deduction in four years will save how much tax in
today’s dollars? Use Exhibit 3.1. (Round
discount factor(s) to three decimal places.)
1. A)
$30,000.
2. B)
$7,500.
3. C)
$23,760.
4. D)
$5,940.
5. E)
None of the choices are correct.
48) If Jim invested $100,000 in an annual dividend-paying stock
today with a 7 percent return, what investment time period will give Jim the
greatest after-tax return?
1. A) 1
year.
2. B) 5
years.
3. C) 10
years.
4. D) 20
years.
5. E)
All yield the same after-tax return.
49) If Julius has a 32 percent tax rate and a 10 percent
after-tax rate of return, a $40,000 tax deduction in two years will save how
much tax in today’s dollars?Use Exhibit 3.1. (Round discount factor(s) to three
decimal places.)
1. A)
$40,000.
2. B)
$10,573.
3. C)
$33,040.
4. D)
$12,800.
5. E)
None of the choices are correct.
50) If Thomas has a 37 percent tax rate and a 6 percent
after-tax rate of return, $50,000 of income in five years will cost him how
much tax in today’s dollars? Use Exhibit 3.1. (Round discount factor(s) to three
decimal places.)
1. A)
$50,000.
2. B)
$18,500.
3. C)
$37,350.
4. D)
$13,820
5. E)
None of the choices are correct.
51) If Julius has a 22 percent tax rate and a 10 percent
after-tax rate of return, $25,000 of income in three years will cost him how
much tax in today’s dollars? Use Exhibit 3.1. (Round discount factor(s) to
three decimal places.)
131.
A) $4,131.
132.
B) $18,775.
133.
C) $5,500.
134.
D) $25,000.
135.
E) None of the choices are correct.
52) Which of the following increases the benefits of income
deferral?
1. A)
Increasing tax rates.
2. B)
Smaller after-tax rate of return.
3. C)
Larger after-tax rate of return.
4. D)
Smaller magnitude of transactions.
5. E)
None of the choices are correct.
53) Which of the following decreases the benefits of
accelerating deductions?
1. A)
Decreasing tax rates.
2. B)
Smaller after-tax rate of return.
3. C)
Larger after-tax rate of return.
4. D)
Larger magnitude of transactions.
5. E)
None of the choices are correct.
54) Which of the following does not limit the benefits of
deferring income?
1. A)
Increasing tax rates.
2. B) A
taxpayer with severe cash flow needs.
3. C) If
continuing an investment would generate a low rate of return.
4. D) If
continuing an investment would subject the taxpayer to unnecessary risk.
5. E)
None of the choices are correct.
55) The constructive receipt doctrine:
1. A) is
particularly restrictive for accrual-basis taxpayers.
2. B)
causes income to be recognized before it is actually received.
3. C)
causes income to be recognized after it is actually received.
4. D)
applies equally to income and expenses.
5. E)
None of the choices are correct.
56) Rolando’s employer pays year-end bonuses each year on December
31. Rolando, a cash-basis taxpayer, would prefer not to pay tax on his bonus
this year. So, he leaves town on December 31, 2018, and doesn’t pick up his
check until January 2, 2019. When should Rolando report his bonus?
2019.
A) 2019.
2020.
B) 2018.
2021.
C) Rolando can choose the year to report the income.
2022.
D) it does not matter.
2023.
E) None of the choices are correct.
57) If tax rates are decreasing:
1. A)
taxpayers should accelerate income.
2. B)
taxpayers should defer deductions.
3. C)
taxpayers should defer income.
4. D)
taxpayers should defer deductions and accelerate income.
5. E)
None of the choices are correct.
58) If tax rates are decreasing:
1. A)
taxpayers should accelerate income.
2. B)
taxpayers should defer deductions.
3. C)
taxpayers should accelerate deductions.
4. D) taxpayers
should defer deductions and accelerate income.
5. E)
None of the choices are correct.
59) If tax rates are increasing:
1. A)
taxpayers should accelerate income.
2. B)
taxpayers should defer deductions.
3. C)
taxpayers should defer income.
4. D)
you need more information to make a recommendation.
5. E)
None of the choices are correct.
60) Which of the following is not required to determine the best
timing strategy?
1. A)
The taxpayer’s after-tax rate of return.
2. B)
The taxpayer’s tax rate this year.
3. C)
The taxpayer’s tax rate in future years.
4. D)
The taxpayer’s tax rate last year.
5. E)
None of the choices are correct.
61) Which of the following is an example of the timing strategy?
1. A) A
corporation paying its shareholders a $20,000 dividend.
2. B) A
parent employing her child in the family business.
3. C) A
taxpayer gifting stock to his children.
4. D) A
cash-basis business delaying billing its customers until after year-end.
5. E)
None of the choices are correct.
62) Which of the following is an example of the timing strategy?
1. A) A
cash-basis taxpayer paying all outstanding bills by year-end.
2. B) A
parent employing her child in the family business.
3. C) A
business paying its owner a $30,000 salary.
4. D) A
taxpayer investing in a tax-preferred investment.
5. E)
None of the choices are correct.
63) Which of the following does not limit the income-shifting
strategy?
1. A)
Assignment of income doctrine.
2. B)
Business purpose doctrine.
3. C)
Substance-over-form doctrine.
4. D)
Step-transaction doctrine.
5. E)
None of the choices are correct.
64) A taxpayer paying his 10-year-old daughter $50,000 a year
for consulting likely violates which doctrine?
1. A)
Constructive receipt doctrine.
2. B)
Implicit tax doctrine.
3. C)
Substance-over-form doctrine.
4. D)
Step-transaction doctrine.
5. E)
None of the choices are correct.
65) 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?
1. A)
Constructive receipt doctrine.
2. B)
Implicit tax doctrine.
3. C)
Assignment of income doctrine.
4. D)
Step-transaction doctrine.
5. E)
None of the choices are correct.
66) Which of the following is needed to implement the
income-shifting strategy?
1. A)
Taxpayers with varying tax rates.
2. B)
Decreasing tax rates.
3. C)
Increasing tax rates.
4. D)
Unrelated taxpayers.
5. E)
None of the choices are correct.
67) A common income-shifting strategy is to:
1. A)
shift income from low tax rate taxpayers to high tax rate taxpayers.
2. B)
shift deductions from low tax rate taxpayers to high tax rate taxpayers.
3. C)
shift deductions from high tax rate taxpayers to low tax rate taxpayers.
4. D)
accelerate tax deductions.
5. E)
None of the choices are correct.
68) 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?
2018.
A) Julie in 2018.
2019.
B) Julie in 2019.
2020.
C) Jason in 2018.
2021.
D) Jason in 2019.
2022.
E) None of the choices are correct.
69) Which of the following is more likely to receive IRS
scrutiny under the assignment of income doctrine?
1. A) A
corporation paying its shareholders a $20,000 dividend.
2. B) A
parent employing her child in the family business.
3. C) A
taxpayer gifting stock to his children.
4. D) A
cash-basis business delaying billing its customers until after year-end.
5. E)
None of the choices are correct.
70) Which of the following is an example of the income-shifting
strategy?
1. A) A
corporation paying its shareholders a $20,000 dividend.
2. B) A
corporation paying its owner a $20,000 salary.
3. C) A
high tax rate taxpayer investing in tax-exempt municipal bonds.
4. D) A
cash-basis business delaying billing its customers until after year-end.
5. E)
None of the choices are correct.
71) Which of the following is an example of the conversion
strategy?
1. A) A
corporation paying its shareholders a $20,000 dividend.
2. B) A
corporation paying its owner a $20,000 salary.
3. C) A
high tax rate taxpayer investing in tax exempt municipal bonds.
4. D) A
cash-basis business delaying billing its customers until after year end.
5. E)
None of the choices are correct.
72) Which of the following may limit the conversion strategy?
1. A)
Implicit taxes.
2. B)
Assignment of income doctrine.
3. C)
Constructive receipt doctrine.
4. D)
Activities with preferential tax rates.
5. E)
None of the choices are correct.
73) 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?
32.
A) 32.00 percent.
33.
B) 10.40 percent.
34.
C) 8.00 percent.
35.
D) 7.00 percent.
36.
E) None of the choices are correct.
74) 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?
37.
A) 37.00 percent.
38.
B) 9.52 percent.
39.
C) 6.00 percent.
40.
D) 3.78 percent.
41.
E) None of the choices are correct.
75) 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?
24.
A) 24.00 percent.
25.
B) 12.00 percent.
26.
C) 10.00 percent.
27.
D) 7.60 percent.
28.
E) None of the choices are correct.
76) 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?
1. A) 22
percent.
2. B) 5
percent.
3. C) 7
percent.
4. D)
3.9 percent.
5. E)
None of the choices are correct.
77) 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?
1. A) 50
percent.
2. B) 40
percent.
3. C) 30
percent.
4. D) 20
percent.
5. E)
None of the choices are correct.
78) 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?
1. A) 50
percent.
2. B) 40
percent.
3. C) 30
percent.
4. D) 20
percent.
5. E)
None of the choices are correct.
79) 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?
32.
A) 32.00 percent
33.
B) 15.00 percent.
34.
C) 8.00 percent.
35.
D) 6.80 percent.
36.
E) None of the choices are correct.
80) 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?
15.
A) 15.00 percent.
16.
B) 10.00 percent.
17.
C) 9.00 percent.
18.
D) 7.65 percent.
19.
E) None of the choices are correct.
81) Assume that Shavonne’s marginal tax rate is 37 percent and
her tax rate on dividends is 15 percent. If a corporate bond pays 10.20 percent
interest, what dividend yield would a dividend-paying stock (with no growth
potential) have to offer for Shavonne to be indifferent between the two
investments from a cash-flow perspective?
6. A)
6.43 percent.
7. B)
7.56 percent.
8. C)
10.20 percent
9. D)
15.00 percent
10.
E) None of the choices are correct.
82) Assume that Will’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 a dividend yield of 8 percent, what interest rate must the
corporate bond offer for Will to be indifferent between the two investments
from a cash-flow perspective?
1. A) 12
percent.
2. B) 11
percent.
3. C) 10
percent.
4. D) 8
percent.
5. E)
None of the choices are correct.
83) Assume that Jose is indifferent between investing in a
corporate bond that pays 10 percent interest and a stock with no growth
potential that pays an 8 percent dividend yield. Assume that the tax rate on
dividends is 15 percent. What is Jose’s marginal tax rate?
1. A) 47
percent.
2. B) 37
percent.
3. C) 32
percent.
4. D) 15
percent.
5. E)
None of the choices are correct.
84) Assume that Juanita is indifferent between investing in a
corporate bond that pays 10.20 percent interest and a stock with no growth
potential that pays a 6 percent dividend yield. Assume that the tax rate on
dividends is 15 percent. What is Juanita’s marginal tax rate?
1. A) 50
percent.
2. B) 40
percent.
3. C) 30
percent.
4. D) 15
percent.
5. E)
None of the choices are correct.
85) If Tom invests $60,000 in a taxable corporate bond that
provides a 5 percent before-tax return, how much will Tom’s investment be worth
in either 8 or 20 years from now when the bond matures? Assume Tom’s marginal
tax rate is 35 percent.
198.
A) $88,647; $159,198.
199.
B) $92,782; $178,414.
200.
C) $79,621; $121,716.
201.
D) $77,495; $113,750.
202.
E) None of the choices are correct.
86) The income-shifting and timing strategies are examples of:
1. A)
tax avoidance.
2. B)
tax evasion.
3. C)
illegal taxpayer strategies.
4. D)
All of the choices are correct.
5. E)
None of the choices are correct.
87) A taxpayer earning income in “cash” and not reporting it as
taxable income is an example of:
1. A)
tax avoidance.
2. B)
tax evasion.
3. C)
conversion.
4. D)
income shifting.
5. E)
None of the choices are correct.
88) Investing in municipal bonds to avoid paying tax on interest
earned and to earn a higher after-tax yield is an example of:
1. A)
conversion.
2. B)
tax evasion.
3. C)
timing.
4. D)
income shifting.
5. E)
None of the choices are correct.
89) Paying “fabricated” expenses in high tax rate years is an
example of:
1. A)
conversion.
2. B)
tax evasion.
3. C)
timing.
4. D)
income shifting.
5. E)
None of the choices are correct.
90) Danny argues that tax accountants suffer from one-mindedness
in their attempts at tax planning (i.e., reducing taxes at all costs). Is
Danny’s view of tax planning correct—i.e., does he understand what the goal of
tax planning is? Please elaborate.
91) An astute tax student once summarized that many of the tax
planning strategies merely make use of the variation of taxation across
different dimensions. Explain why this is true. Be specific.
92) There are two basic timing-related tax rate strategies. What
are they? What is the intent of each strategy? In which situations do the tax
rate and timing strategies provide conflicting recommendations? What
information do you need to determine the appropriate action?
93) Based only on the information provided for each scenario,
determine whether Eddy or Scott will benefit more from using the timing
strategy and why there will be a benefit to that person. Use Exhibit 3.1.
1. Eddy
has a 40 percent tax rate. Scott has a 30 percent tax rate.
2. Eddy
and Scott each have a 40 percent tax rate. Eddy has $10,000 of income that
could be deferred; Scott has $20,000 of income that could be shifted.
3. Eddy
and Scott each have a 40 percent tax rate and $20,000 of income that could be
deferred. Eddy’s after-tax rate of return is 8 percent. Scott’s after-tax rate
of return is 10 percent.
4. Eddy
and Scott each have a 40 percent tax rate, $20,000 of income that could be
deferred, and an after-tax rate of return of 10 percent. Eddy can defer income
up to three years. Scott can defer income up to two years.
94) Based only on the information provided for each scenario,
determine whether Kristi or Cindy will benefit more from using the timing
strategy and why there will be a benefit to that person. Use Exhibit 3.1.
(Round discount factor(s) to three decimal places.)
1. Kristi
has a 40 percent tax rate and can defer $20,000 of income. Cindy has a 30
percent tax rate and can defer $30,000 of income.
2. Kristy
has a 30 percent tax rate and a 10 percent after-tax rate of return and can
defer $25,000 of income for three years. Cindy has a 40 percent tax rate and an
8 percent after-tax rate of return and can defer $20,000 of income for four
years.
95) David, an attorney and cash-basis taxpayer, is new to the
concept of tax planning and recently learned of the timing strategy. To
implement the timing strategy, David plans to establish a new policy that
allows his clients to wait up to five years to pay their attorney fees. Assume
that David expects his marginal tax rates to remain constant over the
foreseeable future. What is wrong with this strategy?
96) Explain why $1 today is not equal to $1 in the future. Why
is understanding this concept particularly important for tax planning? What tax
strategy exploits this concept?
97) Luther was very excited to hear about the potential tax
savings from shifting income from his corporation to himself. The next day he
had his corporation declare a $30,000 dividend to him. Is this an effective
income-shifting strategy? If so, why? If not, why not? What recommendations do
you have for Luther?
98) Compare and contrast the constructive receipt doctrine and
the assignment of income doctrine.
In what situations do these doctrines apply? What tax planning
strategies does each doctrine limit?
99) Lucinda is contemplating a long-range planning strategy that
will allow her to defer sizable portions of her income for 10 years. What type
of planning strategy is she contemplating? What are some potential risks
associated with this type of strategy?
100) Jared, a tax novice, has recently learned of several
foreign tax havens (i.e., countries with low tax rates). He is considering
locating his manufacturing operations in one of these countries solely based on
their low tax rates. What types of taxes is Jared ignoring? Explain how these
other taxes may affect the viability of Jared’s choice to locate in a foreign
tax haven.
101) Richard recently received $10,000 of compensation for some
consulting work (paid in cash). Jeffrey recently received $10,000 of interest
income from city of Dallas bonds. Both taxpayers report no taxable income from
these transactions. Is this considered tax avoidance or tax evasion? What is
the difference, if any, between the two?
102) Antonella works for a company that pays a year-end bonus in
December of each year. Assume that Antonella expects to receive a $20,000 bonus
in December this year, her tax rate is 30 percent, and her after-tax rate of
return is 8 percent. If Antonella’s employer paid her bonus on January 1 of
next year instead of in December, how much would this action save Antonella in
today’s tax dollars? If Antonella’s tax rate increased to 32 percent next year,
would receiving the bonus in January still be advantageous? Use Exhibit 3.1.
103) Joe Harry, a cash-basis taxpayer, owes $20,000 in
tax-deductible accounting fees for his business. Assume that it is December
28th and that Joe Harry can avoid any finance charges if he pays the
accounting fees by January 10th. Joe Harry’s tax rate this year is 24 percent.
His tax rate next year will be 32 percent. His after-tax rate of return is 8 percent.
When should Joe Harry pay the $20,000 fees and why? Use Exhibit 3.1. (Round discount factor(s) to
three decimal places.)
104) Rodney, a cash-basis taxpayer, owes $40,000 in
tax-deductible consulting fees for his business. Assume that it is December
28th and that Rodney can avoid any finance charges if he pays the
accounting fees by January 10th. Rodney’s tax rate this year is 32 percent and
his after-tax rate of return is 10 percent. What tax rate next year will make
Rodney indifferent between paying the $40,000 this year or next year? Use
Exhibit 3.1. (Round
discount factor(s) to three decimal places.)
105) Troy is not a very astute investor. He has a knack for
investing in losing stocks. In his latest investment move, he has realized a
loss of about $40,000 (original basis of $50,000; current fair market value of
$10,000) in High Tech, Inc. The good news is that unlike prior years, he
actually has $45,000 of gains that he can use to offset the loss. Troy is
considering either selling the High Tech, Inc. stock to his sister, Louise, or
on the stock market. Which should he choose and why? Please explain why the IRS
may treat the two transactions differently.
106) O’Reilly is a masterful lottery player. The megamillion
jackpot is now up to $200 million. If O’Reilly wins the jackpot, he has a
choice of receiving $200 million in five years or a smaller lump sum now.
Advise O’Reilly on his choice under the following scenarios. Which option
should he take and why? Use Exhibit 3.1.
1. O’Reilly’s
after-tax return is 10 percent. If he chooses the current lump-sum option, the
lottery will pay him $130 million.
2. O’Reilly’s
after-tax return is 10 percent. His current tax rate will be 35 percent if he
receives the lottery payment now. His expected tax rate in five years will be
40 percent. If he chooses the current lump-sum option, the lottery will pay him
$100 million.
107) Sal, a calendar-year taxpayer, uses the cash-basis method
of accounting for his sole proprietorship. In late December he performed
$40,000 of consulting services for a client. Sal typically requires his clients
to pay his bills immediately upon receipt. Assume that Sal’s marginal tax rate
is 32 percent this year and 37 percent next year and that he can earn an
after-tax rate of return of 12 percent on his investments. Should Sal send his
client the bill in December or January? Use Exhibit 3.1. (Round discount factor(s) to
three decimal places.)
108) Lucky owns a maid service that cleans several local
businesses nightly. Lucky, a high tax rate taxpayer, would like to shift some
income to his son Rocco. Lucky tells all of his customers (who are always
timely in their payments) to pay Rocco, and then Rocco will report 50 percent
of the income as a collection fee. Lucky will report the remaining 50 percent.
Will this shift the income from Lucky to Rocco? Why or why not? What doctrines
influence your answer? Any suggestions for Lucky?
109) Bono owns and operates a sole proprietorship and has a 32
percent marginal tax rate. He provides his son, Richie, $12,000 a year for
college expenses. Richie works as a street musician and has a marginal tax rate
of 15 percent. What could Bono do to reduce his family tax burden? How much
pretax income does it currently take Bono to generate the $12,000 after taxes
given to Richie? If Richie worked for his father’s sole proprietorship, what
salary would Bono have to pay him to generate $12,000 after taxes? (Ignore any
Social Security, Medicare, or self-employment tax issues.) How much money would
this strategy save?
110) Jayzee is a single taxpayer who operates a sole
proprietorship. He expects his taxable income next year to be $150,000, of
which $125,000 is attributed to his sole proprietorship. Jayzee is
contemplating incorporating his sole proprietorship. Using the 2019 single
individual tax brackets and the corporate tax brackets, how much current tax
could this strategy save Jayzee? (Ignore any Social Security, Medicare, or
self-employment tax issues.) How much income should be retained in the
corporation? (Use tax rate schedule)
111) Bobby and Whitney are husband and wife, and Whitney
operates a sole proprietorship. They expect their joint taxable income next
year to be $225,000, of which $175,000 is attributed to the sole
proprietorship. Whitney is contemplating incorporating the sole proprietorship.
Using the 2019 married filing jointly tax brackets and the corporate tax
brackets, how much current tax could this strategy save Bobby and Whitney? How
much income should be retained in the corporation? (Use tax rate schedule.)
112) Rob is currently considering investing in municipal bonds
that earn 4 percent interest or taxable bonds issued by Dell Computer that pay
6.5 percent. If Rob’s 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 to the municipal bond or to the corporate bond? What strategy is
this decision based upon?
113) Maurice is currently considering investing in a high dividend
yield stock with no growth potential that pays a 6 percent dividend yield or
bonds issued by the Coca-Cola Company that pay 8 percent. If Maurice’s ordinary
tax rate is 25 percent and his dividend tax rate is 15 percent, which
investment should he choose? Which investment should he choose if his ordinary
tax rate is 30 percent? At what ordinary tax rate would he be indifferent
between the stock or the bond? What strategy is this decision based upon?
114) Susan Brown has decided that she would like to go back to
school after her kids leave home in five years. To save for her education,
Susan would like to invest $25,000 in an investment that provides a high
return. If her marginal tax rate is 35 percent, what is Susan’s after-tax rate
of return for the following investment options? Qualified dividends are taxed
at 15 percent.
(1) Corporate bond issued at face value with 10 percent stated
interest rate payable annually.
(2) Dividend-paying stock with an annual qualifying dividend
equal to 10 percent of her investment.
(3) Growth stock with an annual growth rate of 8 percent and no
dividends paid. (Round
your interim calculations to the nearest whole number.)
115) Boeing is considering opening a plant in one of two
neighboring states. One state has a corporate tax rate of 15 percent. If
operated in this state, the plant is expected to generate $1,200,000 pretax
profit. The other state has a corporate tax rate of 5 percent. If operated in
this state, the plant is expected to generate $1,085,000 of pretax profit.
Which state should Boeing choose based upon tax considerations only? Why do you
think the plant in the state with a lower tax rate would produce a lower pretax
income?
Essentials of Federal Taxation, 11e (Spilker)
Chapter 5 Gross Income and Exclusions
1) Gross income includes all income realized during the year.
2) Excluded income will never be subject to the federal income
tax.
3) The all-inclusive definition of income means that gross
income is defined very broadly.
4) A taxpayer who borrows money will include the amount borrowed
in their gross income under the all-inclusive definition of income.
5) Realized income is included in gross income unless a tax
provision specifies that it can be deferred or excluded.
6) The principle of realization for tax purposes is very
different from realization as it is understood for financial reporting
purposes.
7) Wherewithal to pay represents the principle that a realized
transaction should require a taxpayer to sell other assets in order to pay
income taxes.
8) Barter clubs are an effective means of avoiding realization
for tax purposes.
9) The cash method of accounting requires taxpayers to recognize
income only when that income is received as cash.
10) When a carpenter provides $100 of services in exchange for
$100 of groceries, the carpenter has realized $100 of income.
11) Recognized income may be in the form of cash or property
received (but not services received).
12) When a taxpayer sells an asset, the entire proceeds from the
sale must be included in gross income regardless of the cost of the asset.
13) Jake sold his car for $2,400 in cash this year. He will
realize a taxable gain of $1,000 if he purchased the car for $1,400.
14) When an asset is sold, the taxpayer calculates the gain or
loss by subtracting the tax basis of the asset from the proceeds of the sale.
15) The tax benefit rule applies when a taxpayer refunds amounts
that were previously included in income.
16) Jim received a $500 refund of state income taxes this year.
Jim will not need to include the $500 in his gross income this year because he
did not deduct state income taxes last year.
17) Constructive receipt represents the principle that
cash-basis taxpayers should be taxed on income when it is made available to
them without substantial restrictions.
18) Claim of right states that income has been realized if a
taxpayer receives income and there are substantial restrictions on the
taxpayer’s use of the income.
19) Community property laws dictate that income earned by one
spouse is treated as though it were earned equally by both spouses.
20) The date on which stock options are given to the employee is
called the exercise date.
21) The date on which stock options are no longer subject to
forfeiture is called the vesting date.
22) When stock options are exercised, they are converted into
actual employer stock.
23) Interest income is earned in the year in which it is
received by the taxpayer or credited to the bank account.
24) The assignment of income doctrine requires that to shift
taxable income from property to another person, the taxpayer must transfer only
the income to the other person.
25) For tax purposes, unearned income means income that has not
yet been realized.
26) A portion of each payment from a purchased annuity
represents income.
27) The exclusion ratio for a purchased annuity is the cost of
the annuity divided by the interest rate.
28) The capital gains (losses) netting process for taxpayers
without 25 or 28 percent capital gains requires them to (1) net short-term and
long-term gains, (2) net short-term and long-term losses, and (3) net the
outcome to yield a final gain or loss to place on the tax return.
29) Dave and Jane file a joint return. They sell a capital asset
at a $150,000 loss. Even though they have no capital gains, $6,000 of the loss
can still be deducted in the current year.
30) Unrecaptured §1250 gain is taxed at the 28 percent
preferential capital gains rate.
31) Losses associated with personal-use assets, sales to related
parties, and wash sales are not currently deductible.
32) Capital loss carryovers for individuals are carried forward
indefinitely.
33) Rental income generated by a partnership is reported by partners
as dividend income.
34) The tax law defines alimony to include transfers of property
(but not cash) between former spouses.
35) Regardless of when a divorce agreement is executed, alimony
is included in gross income of the recipient and deductible for AGI by the
payor.
36) Prizes and awards are generally taxable.
37) Gambling winnings are included in gross income only to the
extent that the winnings exceed gambling losses incurred during the same
period.
38) Generally, 85 percent of Social Security benefits are
included in income of high-income taxpayers.
39) Unemployment benefits are excluded from gross income.
40) A taxpayer generally includes in gross income the amount of
debt forgiven by a lender.
41) An employee may exclude up to a 40 percent employer-provided
discount on services.
42) A below-market loan (e.g., from an employer to an employee)
is a common example of a transaction that generates taxable imputed income.
43) Interest earned on a federal Treasury bond is excluded from
gross income (for federal tax purposes).
44) Interest earned on a city of Denver bond is excluded from
gross income (for federal tax purposes).
45) Taxpayers meeting certain home ownership and use
requirements can permanently exclude up to $1,000,000 of realized gain on the
sale of their principal residence.
46) Qualified fringe benefits received by an employee can be
excluded from gross income.
47) Scholarships are excluded from gross income for degree
candidates even if the scholarship pays for required fees and books in addition
to tuition.
48) Earnings from Internal Revenue Code Section 529 plans and
Coverdell education savings accounts are excluded from gross income if the
earnings are used to pay for qualifying educational expenditures for college
students (and not for elementary or secondary education).
49) Trevor received a gift of $25,000 in cash from his rich
uncle. Trevor must include $15,000 of this gift in his gross income this year.
50) Anna received $15,000 from life insurance paid upon the
death of her grandmother. Anna can exclude the entire amount of the life
insurance from her gross income.
51) U.S. citizens generally are subject to tax on all income
whether it is generated in the United States or in foreign countries.
52) To provide relief from double taxation, Congress allows a
foreign-unearned income exclusion for interest and dividends earned in foreign
countries.
53) Workers’ compensation benefits are excluded from gross
income.
54) Fred must include in gross income a $7,500 payment received
from his neighbor to compensate Fred for the emotional distress he suffered
when his neighbor accidentally ran over his dog.
55) Loretta received $6,200 from disability insurance that she
purchased directly this year. Loretta must include all $6,200 in her gross
income.
56) Brad was disabled for part of the year and he received
$11,500 of benefits from a disability plan purchased by Brad’s employer as a
nontaxable fringe benefit. Brad must include all $11,500 of benefits in his
gross income because Brad was not taxed on the disability insurance premiums
paid by his employer.
57) Qualified retirement plans include defined benefit plans but
not defined contribution plans.
58) Defined benefit plans specify the amount of benefit an
employee will receive on retirement while defined contribution plans specify
the amounts that employers and employees will (or can) contribute to an
employee’s plan.
59) The standard retirement benefit an employee will receive
under a defined benefit plan depends on the number of years of service the
employee provides, but does not consider the amount of the employee’s
compensation near retirement.
60) Distributions from defined benefit plans are taxed as
long-term capital gains to beneficiaries.
61) Taxpayers withdrawing funds from an IRA before they turn 70½
are generally subject to a 10 percent penalty on the amount of the withdrawal.
62) Both employers and employees may contribute to defined
contribution plans. However, the amount that employees may contribute to the
plan in a given year is limited by the tax law while the amount that employers
may contribute is not.
63) When an employer matches an employee’s contribution to the
employee’s 401(k) account, the employee is immediately taxed on the amount of
the employer’s matching contribution.
64) Employees who are at least 50 years old at the end of the
year are allowed to contribute more to their 401(k) accounts than employees who
are not 50 years old by year-end.
65) Heidi retired from GE (her employer) at age 56. At the end
of the year, when she was 56 years of age, Heidi received a distribution from
her GE-sponsored 401(k) account. Because Heidi was not at least 59½ years of
age at the time of the distribution, she must pay tax on the full amount of the
distribution and a 10 percent penalty on the full amount of the distribution.
66) Retired taxpayers over 59½ years of age at the end of the
year must receive minimum distributions from defined contribution plans or they
are subject to a penalty.
67) Gross income includes:
1. A)
all income from whatever source derived unless excluded by law.
2. B)
excluded income.
3. C)
deferred income.
4. D)
all realized income.
5. E)
All of these choices are correct.
68) Which of the following is not a necessary
condition for income to be included in gross income?
1. A)
income must be realized
2. B)
income must be paid in cash
3. C)
income cannot be excluded by law
4. D)
income must be made available to a taxpayer on the cash basis
5. E)
All of these choices are correct
69) Sally is a cash-basis taxpayer and a member of the Valley
Barter Club. This year Sally provided 100 hours of sewing services to the
barter club in exchange for two football playoff tickets. Which of the
following is a true statement?
1. A)
Sally need not recognize any gross income unless she sells the football
tickets.
2. B)
Sally’s exchange does not result in taxable income.
3. C)
Sally is taxed on the value of the football tickets even if she cannot attend
the game.
4. D)
Sally is taxed on the value of her sewing services only if she is a
professional seamstress.
5. E)
All of these choices are correct.
70) This year Barney purchased 500 shares of Bell common stock
for $20 per share. At year-end the Bell shares were only worth $2 per share.
What amount can Barney deduct as a loss this year?
1. A)
$10,000
2. B)
$9,000
3. C)
$1,000
4. D)
Barney can deduct $10,000 only if he includes $1,000 in his taxable income.
5. E)
None of the choices are correct—Barney is not entitled to a loss deduction.
71) Hillary is a cash-basis calendar-year taxpayer. During the
last week of December, she received a letter containing a $5,000 check for
services. Which of the following is a true statement?
1. A)
Hillary is taxed on the $5,000 of service income in the year she cashes the
check.
2. B)
Hillary is taxed on the $5,000 of service income in the year the check was
mailed.
3. C)
Hillary is taxed on the $5,000 of service income in the year she receives the
check.
4. D)
Hillary is taxed on the $5,000 of service income in the year she provides the
services.
5. E)
None of the choices are correct.
72) Identify the rule that determines whether a taxpayer must
include in income a refund of an amount deducted in a previous year:
1. A)
Tax refund rule
2. B)
Constructive receipt
3. C)
Return of capital principle
4. D)
Tax benefit rule
5. E)
None of the choices are true
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