Topic 2- Individual Income Tax Formula Chapter 3

Question 1

Virtually every transaction involves the taxpayer and two other parties that have an interest in the tax ramifications of the transaction.

T/F

Answer 1

True

Virtually every transaction involves the taxpayer, the other transacting party, and the government.

Question 2

The timing strategy is particularly effective for cash basis taxpayers.

T/F

Answer 2

True

Question 3

If tax rates will be lower next year, taxpayers should accelerate their deductions regardless of their after-tax rate of return.

T/F

Answer 3

True

Question 4

The conversion strategy capitalizes on the fact that tax rates vary across different activities.

T/F

Answer 4

True

Question 5

If tax rates are decreasing:

taxpayers should accelerate income.
taxpayers should defer deductions.
taxpayers should accelerate deductions.
taxpayers should defer deductions and accelerate income.

Answer 5

taxpayers should accelerate deductions.

Question 6

Which of the following is an example of the timing strategy?

Multiple Choice
A corporation paying its shareholders a $20,000 dividend.
A parent employing her child in the family business.
A taxpayer gifting stock to his children.
A cash-basis business delaying billing its customers until after year end.

Answer 6

A cash-basis business delaying billing its customers until after year end.

Question 7

Which of the following is an example of the income shifting strategy?

Multiple Choice
A corporation paying its shareholders a $20,000 dividend.
A corporation paying its owner a $20,000 salary.
A high tax rate taxpayer investing in tax exempt municipal bonds.
A cash-basis business delaying billing its customers until after year end.

Answer 7

A corporation paying its owner a $20,000 salary.

Question 8

Assume that John’s marginal tax rate is 40%. If a city of Austin bond pays 6% interest, what interest rate would a corporate bond have to offer for John to be indifferent between the two bonds?

Multiple Choice

30. 00%.
31. 00%.
32. 00%.
33. 60%.

Answer 8

Explanation

6%/(1 − 0.40) = 10.00%

Question 9

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.

a. What is the after-tax cost if Isabel pays the $20,000 bill in December?

Answer 9

12,000

Question 10

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.

b. What is the after-tax cost if Isabel pays the $20,000 bill in January?

Use Exhibit 3.1.
.893

Answer 10

$20,000 tax deduction × 40 percent marginal tax rate = $8,000 in tax savings in one year.

Present Value of tax savings = $8,000 × 0.893 (Discount factor, 1 Year, 12 percent)

                                       = $7,144

After-tax cost = Pretax cost − Present value tax savings

                  = $20,000 − $7,144 = $12,856

Question 11

Tawana owns and operates a sole proprietorship and has a 37 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?

Employ her son in her sole proprietorship
Ask Jonathon to find a new job
Start a new enterprise

Answer 11

Tawana could reduce her family’s tax burden by employing her son in her sole proprietorship, thus shifting income taxed at 37 percent (Tawana’s marginal tax rate) to 15 percent (Jonathon’s tax rate).

Question 12

Tawana owns and operates a sole proprietorship and has a 37 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.

b. How much pretax income does it currently take Tawana to generate the $8,000 (after taxes) given to Jonathon? (Round your answer to the nearest whole dollar amount.)

Answer 12

It currently takes Tawana $12,698 of pretax income to generate the $8,000 after-taxes given to Jonathon.

After-tax income = Pretax income × (1 − Marginal tax rate)

$8,000 = Pretax income × (1 − 0.37)

Pretax income = $8,000/(0.63) = $12,698.

Question 13

Tawana owns and operates a sole proprietorship and has a 37 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.

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)? (Round your answer to the nearest whole dollar amount.)

Answer 13

If Jonathon worked for Tawana’s sole proprietorship, she would only have to pay him $9,412 to generate $8,000 after-taxes.

After-tax income = Pretax income × (1 − Marginal tax rate)

$8,000 = Pretax income × (1 − 0.15)

Pretax income = $8,000/(0.85) = $9,412.

Question 14

Tawana owns and operates a sole proprietorship and has a 37 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.

d. How much money would this strategy save? (Round your intermediate calculations and final answers to the nearest whole dollar amount.)

(答えるのにbとcが必要）

Answer 14

This strategy will save Tawana $3,286 pretax (i.e., $12,698 − $9,412). The analysis of the after-tax savings from this strategy is as follows:

Tawana pays her son ($9,412). This saves Tawana $3,482 in taxes because the payment is deductible ($9,412 × 37%).

Her son receives $9,412. This costs her son ($1,412) in taxes because he must pay tax on the compensation ($9,412 × 15%). Total savings is $2,070 ($3,482 − $1,412).

The after-tax savings are the result of shifting $9,412 of income from Tawana to her son. Consequently, the family unit is paying taxes on the $9,412 at 15% instead of 37 %. $9,412 × (40% − 15%) = $2,070 after tax savings.