taxation chapter3 - Chapter 3 Tax Planning Strategies and...

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Chapter 3 Tax Planning Strategies and Related Limitations SOLUTIONS MANUAL Discussion Questions (1) [LO1] “The goal of tax planning is to minimize taxes.” Explain why this statement is not true. In general terms, the goal of tax planning is to maximize the taxpayer’s after-tax wealth while simultaneously achieving the taxpayer’s nontax goals. Maximizing after-tax wealth is not necessarily the same as tax minimization. Specifically, maximizing after-tax wealth requires one to consider both the tax and nontax costs and benefits of alternative transactions, whereas tax minimization focuses solely on a single cost (i.e., taxes). (2) [LO1] Describe the three parties engaged in every business transaction and how understanding taxes may aid in structuring transactions. There are three parties involved in virtually every transaction: the taxpayer, the other transacting party, and the government (i.e., the uninvited silent party that specifies the tax consequences of the transaction). Effective tax planning requires an understanding of the tax and nontax costs from the taxpayer’s and other party’s perspectives because tax and nontax factors also influence the other party’s preferences. Understanding these preferences will allow the taxpayer to identify an optimal transaction structure. (3) [LO1] In this chapter we discussed three basic tax planning strategies. What different features of taxation does each of these strategies exploit? The timing strategy exploits the variation in taxation across time – i.e., the “real” tax costs of income decrease as taxation is deferred; the “real” tax savings associated with tax deductions increase as tax deductions are accelerated. The income shifting strategy exploits the variation in taxation across taxpayers. Finally, the conversion strategy exploits the variation in taxation across activities. (4) [LO2] What are the two basic timing strategies? What is the intent of each? The two strategies are deferring taxable income and accelerating tax deductions. The intent of deferring taxable income recognition is to minimize the present value of taxes paid. The intent of accelerating tax deductions is to maximize the present value of tax savings from the deductions.
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(5) [LO2] Why is the timing strategy particularly effective for cash-method taxpayers? The timing strategy is particularly effective for cash-method taxpayers because the deduction year for cash-method taxpayers depends on when the taxpayer pays the expense (which the taxpayer controls). (6) [LO2] What are some common examples of the timing strategy? The timing strategy is an important aspect of investment planning, retirement planning, and property transactions It is also an important aspect of tax planning for everyday business operations (e.g., determining the appropriate period to recognize sales income – upon product shipment, delivery, or customer acceptance).
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