Final

Question 0

Taxable entities

Answer 0

1. Individuals

2. C corporations

Question 1

Basic types of org forms

Answer 1

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

Question 2

Pass-through entities

Answer 2

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

Question 3

Nontaxable entities

Answer 3

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

Question 4

Implicit taxes

Answer 4

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.

Question 5

Tax clientele example

Answer 5

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.

Question 6

Frictions

Answer 6

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

Question 7

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

Answer 7

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.

Question 8

Dividend received deduction

Answer 8

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%

Question 9

How did Seagram pass the substantially disproportionate test?

Answer 9

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.

Question 10

REIT

Answer 10

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

Question 11

Savings vehicles

Answer 11

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

Question 12

Only savings vehicle that the investment tax is deductible

Answer 12

Pension

Question 13

Investment vehicles that are taxed annually are

Answer 13

1. Money market

2. Mutual fund

Question 14

Investment vehicle where earnings are never taxed

Answer 14

Insurance policy

Question 15

Investment vehicle where earnings taxes are deferred include

Answer 15

1. Single premium deferred annuity
2. Foreign corporation
3. Pensions

Question 16

Investment vehicles that are taxed at the capital gains rate

Answer 16

1. Mutual fund

2. Foreign corporation

Question 17

Vehicles that are taxed at the ordinary income rate

Answer 17

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

Question 18

DRD

Answer 18

Reduces the effective tax rate on dividends

Question 38

When tax rates are increasing over time…

Answer 38

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).

Question 39

Non qualified stock options (NQSOs)

Answer 39

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

Question 40

ISO

Answer 40

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

Question 41

Income shifting schemes

Answer 41

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)

Question 42

Legislative goal: raise revenue

Answer 42

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

Question 43

Legislative goal: reduce executive comp

Answer 43

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

Question 44

Legislative goal: stimulate the economy

Answer 44

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

Question 45

IRA

Answer 45

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)

Question 46

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%

Answer 46

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

Question 47

Step up

Answer 47

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

Question 48

Key tax factors in "tax-free" mergers and acquisitions

Answer 48

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

Question 49

Stepped up basis

Answer 49

If buyers cost basis in targets assets exceeds the carryover basis

Question 50

338(h)(10) election

Answer 50

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)

Question 51

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

Answer 51

No

Question 52

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

Answer 52

Carryover basis since no 338(h)(10)

Question 53

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

Answer 53

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

Question 54

Does employee prefer deferred comp when tax rates decline?

Answer 54

Yes

Question 55

Does employer prefer deferred comp when tax rates increase?

Answer 55

Yes

Question 56

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

Answer 56

No

Question 57

Tax consequence to employee when NQO option is exercised

Answer 57

Ordinary income of Pe-X

Question 58

Tax consequence to employee when ISO option is exercised

Answer 58

None

Question 59

Tax consequence to employer when NQO option is exercised

Answer 59

Ordinary deduction of Pe-X

Question 60

Tax consequence to employer when NQO is sold

Answer 60

None

Question 61

Tax consequence to employer when ISO is sold

Answer 61

None

Question 62

Tax consequence to employee when NQO is sold

Answer 62

Capital gain of Ps-Pe

Question 63

Tax consequence to Employee when ISO stock is sold

Answer 63

Capital gain of Ps-X

Question 64

The ISO is preferred by the employee whenever

Answer 64

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

Question 65

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

Answer 65

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

Question 66

NQOs are preferred if

Answer 66

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

Question 67

The ISO is preferred if

Answer 67

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

Question 68

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

Answer 68

The effective or PV of the capital gains rate declines

Question 69

Sale of stock within 12 months of exercise of an ISO

Answer 69

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

Question 70

Adjusted basis

Answer 70

Cost-depreciation+improvements

Question 71

Character of gains & losses

Answer 71

Ordinary gains/loss - comes from sale of noncapital assets (ie inventory) Capital gain/loss - comes from sales of capital assets (ie securities)

Question 72

Net capital loss for corporations

Answer 72

Corporations get 3 year carryback and 5 year carryover for NCL

Question 73

IRAs

Answer 73

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)

Question 74

Money market observation

Answer 74

Characteristics: 1. No deduction 2. No deferral 3. Ordinary rates Observations: R does not depend on horizon

Question 75

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

Answer 75

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

Question 76

Type III : Mutual Fund with all CG

Answer 76

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

Question 77

Type IV: Growth stock with no dividends

Answer 77

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 g1 (bc of deferral) 4. R grows with horizon