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Taxes > Final > Flashcards

Final Flashcards

0
Q

Taxable entities

A
  1. Individuals

2. C corporations

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1
Q

Basic types of org forms

A
  1. Taxable entities
  2. Pass-through or conduit entities
  3. Tax-exempt
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2
Q

Pass-through entities

A
  1. S corporations
  2. Partnerships
  3. LLCs
  4. LLPs
  5. Mutual funds
  6. REITs
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3
Q

Nontaxable entities

A
  1. Governmental entities
  2. Nonprofits (universities, churches)
  3. Pension funds
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4
Q

Implicit taxes

A

Arise because the before-tax investment returns available on tax-favored assets are less than those available on tax-disfavored assets. Taxpayers wishing to obtain the tax-favored treatment offered by the investment bid up the price of the investment, thus lowering the pretax rate of return.

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5
Q

Tax clientele example

A

High-tax-bracket taxpayers who are more likely to hold tax-exempt municipal bonds rather than taxable corporate bonds and who are more likely to be lessors and owners of depreciable equipment rather than lesses.

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6
Q

Frictions

A

Transaction costs incurred in the marketplace that make implementation of certain tax-planning strategies costly.

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7
Q

What is the purpose of a Dividends received deduction (DRD)?

A

The purpose of a DRD is to avoid triple (or more) taxation on the original corporation’s earnings (once at the original corporation when earned, again at the second corporation when dividends are received, and third at the shareholder level when the second corporation distributes dividends.

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8
Q

Dividend received deduction

A

The DRD allows the firm to exempt a fraction of the dividends received from other corporations. This fraction is currently 70% if the shareholder owns less than 20% of the corporate stock. This fraction increases to 80% (100%) if the corporate shareholder owns more than 20% (80%) of the corporate stock. Thus is a corporation’s marginal tax rate is 35% and it owns more than 20% of the stock, the effective tax rate on dividends is .35 * .20 = 7%

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9
Q

How did Seagram pass the substantially disproportionate test?

A

It sold its DuPont shares and kept the same approximate ownership interest by receiving warrants to buy the issuing corporations stock as part of the proceeds of the sale.

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10
Q

REIT

A

The rent payment to the REIT is tax deductible as a business expense at the state level.

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11
Q

Savings vehicles

A
  1. Money market
  2. Single premium deferred annuity
  3. Mutual fund
  4. Foreign corporation
  5. Insurance policy
  6. Pension
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12
Q

Only savings vehicle that the investment tax is deductible

A

Pension

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13
Q

Investment vehicles that are taxed annually are

A
  1. Money market

2. Mutual fund

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14
Q

Investment vehicle where earnings are never taxed

A

Insurance policy

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15
Q

Investment vehicle where earnings taxes are deferred include

A
  1. Single premium deferred annuity
  2. Foreign corporation
  3. Pensions
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16
Q

Investment vehicles that are taxed at the capital gains rate

A
  1. Mutual fund

2. Foreign corporation

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17
Q

Vehicles that are taxed at the ordinary income rate

A
  1. Money market fund
  2. Single premium deferred annuity
  3. Pension
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18
Q

DRD

A

Reduces the effective tax rate on dividends

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38
Q

When tax rates are increasing over time…

A

Money market accounts (the least tax advantageous organizational form when rates are constant) can provide higher after-tax rates of return than pension accounts (the most tax advantageous when rates are constant).

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39
Q

Non qualified stock options (NQSOs)

A

Preferred by employers bc the issuer is allowed to take a tax deduction equal to the amount the recipient is required to include in his or her income

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40
Q

ISO

A
  1. Employer never gets a tax deduction
  2. Employee doesn’t pay a tax at exercise
  3. Employee tax postponed until sells stock and then gets long term capital gains treatment
  4. Employee must hold stock at least two years after grant date
  5. Employee must hold stock at least one year after exercise date
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41
Q

Income shifting schemes

A
  1. Shift income across time (Hillary Clinton, timing births and deaths)
  2. Shift income from one type to another (from ordinary income to capital gains)
  3. Shift income from one pocket to another (parent to child, US corp to Bermuda corp)
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42
Q

Legislative goal: raise revenue

A

How: tax 100% on everything
Undesired consequences: tax evasion + cash markets
Gov response: more rules, audit, jail

43
Q

Legislative goal: reduce executive comp

A

How: $1mm limit on exec salary
Undesired response: stock options, bonus classification schemes
Gov response: more rules

44
Q

Legislative goal: stimulate the economy

A

How: investment tax credit
Undesired consequence: real estate tax shelters
Response: more rules - have to actively manage properties

45
Q

IRA

A
  1. Similar to pension plans, can often invest pretax dollars
  2. 10% penalty for early withdrawal
  3. Upon withdrawal, taxpayers pays tax on any amount that has not been taxed before (return and any pretax contributions)
46
Q

Deferred comp: how much DC is employer willing to pay in year 5 for $1 if salary today?

N=5; T0=40%; T5=45%; RA=6%

A
  1. $1 * (1-.4) = .60 today ATAX
  2. In year 5, $.60 is equivalent to:
    .60 * (1+ .06)^5 = .8029
  3. .8029/ (1-.45) = $1.46

ER is indifferent between paying .60 today or $1.46 in 5 years

47
Q

Step up

A

Occurs when the tax basis of a target’s assets are written up in value to the purchase price

48
Q

Key tax factors in “tax-free” mergers and acquisitions

A
  1. Generally, no gain or loss is recognized by T
  2. Gain (but not loss) is recognized by T’s shareholders only if they receive boot
  3. A corp takes a “carryover” basis, increased by any gain recognized by the transferor, in the property a acquired (either assets or stock).
  4. T’s tax attributes survive (even in asset acquisitions)
  5. Potential uncertainty regarding “tax-free” status
49
Q

Stepped up basis

A

If buyers cost basis in targets assets exceeds the carryover basis

50
Q

338(h)(10) election

A

Election to treat a stock acquisition of the target as an asset acquisition (which the buyer would want to do if it would receive a stepped up basis in target corps assets)

51
Q

Does a step up make sense for acquisition/sale of free standing c corp?

A

No

52
Q

Taxable stock acquisition (no 338(h)(10) election)

A

Carryover basis since no 338(h)(10)

53
Q

Taxable stock acquisition with a 338(h)(10) election

A

Transaction is taxed as asset sale (taxable asset sale -> step up transaction

54
Q

Does employee prefer deferred comp when tax rates decline?

A

Yes

55
Q

Does employer prefer deferred comp when tax rates increase?

A

Yes

56
Q

If employee can earn better return than the employer, is deferred comp preferable?

A

No

57
Q

Tax consequence to employee when NQO option is exercised

A

Ordinary income of Pe-X

58
Q

Tax consequence to employee when ISO option is exercised

A

None

59
Q

Tax consequence to employer when NQO option is exercised

A

Ordinary deduction of Pe-X

60
Q

Tax consequence to employer when NQO is sold

A

None

61
Q

Tax consequence to employer when ISO is sold

A

None

62
Q

Tax consequence to employee when NQO is sold

A

Capital gain of Ps-Pe

63
Q

Tax consequence to Employee when ISO stock is sold

A

Capital gain of Ps-X

64
Q

The ISO is preferred by the employee whenever

A

The tax rate on ordinary income exceeds the PV of the tax rate on capital gains

65
Q

If ordinary income and capital gains are taxed at the same rate, the employee will prefer…

A

An ISO because the ISO defers the tax on the gain at exercise until the stock is sold

66
Q

NQOs are preferred if

A

The corporation’s marginal tax rate exceeds the difference in the employee’s tax rate on ordinary income less the effective capital gains tax rate divided by 1 minus the employee’s effective capital gains tax rate

67
Q

The ISO is preferred if

A

The incremental taxes to the employee of the NQO exceed the value of the deduction to the employer

68
Q

As the employee’s expected holding period of the stock obtained from exercising an ISO increases

A

The effective or PV of the capital gains rate declines

69
Q

Sale of stock within 12 months of exercise of an ISO

A

Leads to a disqualifying disposition and this increased taxes, NQOs rather than ISOs are more likely to be exercised early for liquidity and/or diversification reasons

70
Q

Adjusted basis

A

Cost-depreciation+improvements

71
Q

Character of gains & losses

A

Ordinary gains/loss - comes from sale of noncapital assets (ie inventory)

Capital gain/loss - comes from sales of capital assets (ie securities)

72
Q

Net capital loss for corporations

A

Corporations get 3 year carryback and 5 year carryover for NCL

73
Q

IRAs

A
  1. Similar to pension plans, can often invest pretax dollars
  2. 10% penalty for early withdrawal
  3. Upon withdrawal, taxpayer pays tax on any amount that has not been taxed before (return and any pretax contribution)
74
Q

Money market observation

A

Characteristics:

  1. No deduction
  2. No deferral
  3. Ordinary rates

Observations:
R does not depend on horizon

75
Q

Type II: Non-deductible IRA (single premium deferred annuity)

A

Characteristics:

  1. No deduction (-)
  2. Deferred (+)
  3. Ordinary rates (-)

Observations:

  1. R grows with horizon bc of deferral
  2. Non-deductible IRA dominates money market if n>1
76
Q

Type III : Mutual Fund with all CG

A

Characteristics:

  1. No deduction
  2. No deferral
  3. Capital gains rates

Observations:

  1. Same as money market but replace t with tcg
  2. If g<1 then this vehicle beats the money market
77
Q

Type IV: Growth stock with no dividends

A

Characteristics:

  1. No deduction
  2. Deferral
  3. Capital gains rates

Observations

  1. Same as non-deductible IRA but taxed at CG rate
  2. Dominates vehicle II if g<i>1 (bc of deferral)</i>
  3. R grows with horizon

Taxes (15 decks)

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