Ch. 3 Problem Solutions

Ch. 3 Problem Solutions - Chapter 03 Tax Planning...

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Chapter 03 Tax Planning Strategies and Related Limitations PROBLEM SOLUTIONS (29) [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? Changes in the control of the White House and Congress may result in a fundamental shift in tax policy. Tax rate changes are rather frequent as lawmakers use them as an integral part of fiscal or economic policy initiatives (e.g., to raise revenue, stimulate the economy, etc.). The risk to Yong is that the newly elected officials will change the tax system in a way that eliminates the benefits of his tax planning strategies (e.g., increasing tax rates in the future may reduce or eliminate the benefits of income deferral). (30) [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? While this plan defers the taxation on the co-pays, it also delays Billups’ receipt of the co-pays. Assuming that Billups doesn’t charge his clients any interest on their delayed payment, this plan will reduce the present value of taxes paid on the co-pays and the present value of the co-pays. The decrease in the present value of the co-pays will exceed the decrease in the present value of the tax paid on the co-pays (not a good thing). In addition, by delaying payment, Billups may increase the likelihood that many of his clients will not pay their co-pays. In summary, this is not a good plan.
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(31) [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? The decrease in the tax rates increases the benefits of the bonus deferral. If Congress instead passed a tax rate increase, the benefit of deferral may be reduced or eliminated. To determine if Tesha should request the company to change its policy this year (i.e., to pay bonuses in December), you need to know the amount of the tax rate increase and Tesha’s after-tax rate of return.
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