Tax and business strategy Questions
with Accurate Answers
FIN 48 - ANSWERSrecognition more likely than not
-assume position will be audited and auditor will have full information
-If MLTN you will prevail on audit, proceed to measurement
-if not MLTN you will prevail, reserve the whole benefit
Measurement: largest amount of tax benefit that is more than 50% of the cumulative
probability of occurring to be realized
requires a reconciliation of unrecognized tax benefits
Liability!
DR. EXP
CR. liability
All parties want to maximize _________. - ANSWERSafter tax returns
banks and customers opposite preferences for interest rate represent a _________. -
ANSWERSmarket
implicit tax - ANSWERSreduction in pretax rate of return driven by reduction (or tax
favoring) in explicit taxes on an investment
municipal bonds
explicit taxes - ANSWERStaxes directly imposed by a government and are easily
quantified
tax planning - ANSWERSIS:
-tax avoidance
-maximizing after tax returns
-minimizing taxes (conditional on maximizing economic income)
-cheating the government
-not paying fair share
IS NOT:
-tax minimization
-tax evasion
Tax payable - ANSWERS=base * rate
,two ways to lower taxes (tax plan) - ANSWERS1. lower the base
2. lower the rate
base and rate can vary across - ANSWERStype of taxpayer
type of income
time
Types of taxpayers - ANSWERS1. taxable: pays tax on its base (income - deductions);
individuals and corporations
2. Exempt: reports income, but is exempt from tax; charities, churches, universities
3. Flow through: reports income, but its taxed on the returns of taxable owners; ps, sole
proprietorship
types of income - ANSWERS1. active (ordinary): salary, business
2. passive: capital gain, dividend, interest, rent
lowering the amount of income tax paid on $1 - ANSWERS1. shift to a lower rate *time*
period
2. shift to lower rate *jurisdiction*
3. shift to a lower rate *structure (org form)*
4. shift to a lower rate *type of income*
when tax avoidance is not possible, tax plannings is about ____________ the payment
of tax - ANSWERSdeferring
for every dollar spent - ANSWERSis it deductible?
are they pre-tax dollars?
does the government contribute?
deductibility, timing, rate
for every dollar earned - ANSWERSis it taxable?
is it not exempt?
does the government share in it (take a cut)?
, deductibility, rate, timing
Asymmetry in the treatment of income and losses - ANSWERSthe government shares
in your income unconditionally and shares in your losses conditional on you having
taxable income in the future
Results in a profitable company spending pre tax dollars; a currently unprofitable (but
eventually profitable) company spending pretax dollars, with a tvm discount; and an
unprofitable company that will never be profitable spending after tax dollars
what restricts tax planning - ANSWERS1. business purpose
2. economic substance
3. substance over form
Suppose a taxpayer invests $100,000 in a partnership. Also assume that as was the
case in the 1970s, the taxpayer faces a personal tax rate of 70% and a tax rate on
capital gains of 28%. In the first year, the partnership spends the entire $100,000 on
research, which the taxpayer can claim as a deduction against her other income. In the
second year, the partnership sells the developed technology, and the taxpayer's share
of the sale price is $50,000, which is taxed as a capital gain. (Ignore the time value of
money in your answer.)
a. What is the pretax rate of return to the taxpayer?
b. what is the after tax rate of return to the taxpayer? - ANSWERSa. Investment =
100,000
End up with = 50,000
Return = 50,000-100,000=-50,000
Rate of return = return/investment = -50/100=-0.5
b. Investment = 30,000 (100,000*(1-0.7)=30,000)
End up with = 36,000 (50,000*(1-.28)=36,000 )
Return = 36,000-30,000=6,000
Rate of return = return/investment = 6/30=0.2
Trade offs in the treatment of losses - ANSWERS1. like profit - cut a check for rate *
loss
2. carry back and/or forward
3. carryback only (deduct against past income)
4. carryforward only (offset future income)
with Accurate Answers
FIN 48 - ANSWERSrecognition more likely than not
-assume position will be audited and auditor will have full information
-If MLTN you will prevail on audit, proceed to measurement
-if not MLTN you will prevail, reserve the whole benefit
Measurement: largest amount of tax benefit that is more than 50% of the cumulative
probability of occurring to be realized
requires a reconciliation of unrecognized tax benefits
Liability!
DR. EXP
CR. liability
All parties want to maximize _________. - ANSWERSafter tax returns
banks and customers opposite preferences for interest rate represent a _________. -
ANSWERSmarket
implicit tax - ANSWERSreduction in pretax rate of return driven by reduction (or tax
favoring) in explicit taxes on an investment
municipal bonds
explicit taxes - ANSWERStaxes directly imposed by a government and are easily
quantified
tax planning - ANSWERSIS:
-tax avoidance
-maximizing after tax returns
-minimizing taxes (conditional on maximizing economic income)
-cheating the government
-not paying fair share
IS NOT:
-tax minimization
-tax evasion
Tax payable - ANSWERS=base * rate
,two ways to lower taxes (tax plan) - ANSWERS1. lower the base
2. lower the rate
base and rate can vary across - ANSWERStype of taxpayer
type of income
time
Types of taxpayers - ANSWERS1. taxable: pays tax on its base (income - deductions);
individuals and corporations
2. Exempt: reports income, but is exempt from tax; charities, churches, universities
3. Flow through: reports income, but its taxed on the returns of taxable owners; ps, sole
proprietorship
types of income - ANSWERS1. active (ordinary): salary, business
2. passive: capital gain, dividend, interest, rent
lowering the amount of income tax paid on $1 - ANSWERS1. shift to a lower rate *time*
period
2. shift to lower rate *jurisdiction*
3. shift to a lower rate *structure (org form)*
4. shift to a lower rate *type of income*
when tax avoidance is not possible, tax plannings is about ____________ the payment
of tax - ANSWERSdeferring
for every dollar spent - ANSWERSis it deductible?
are they pre-tax dollars?
does the government contribute?
deductibility, timing, rate
for every dollar earned - ANSWERSis it taxable?
is it not exempt?
does the government share in it (take a cut)?
, deductibility, rate, timing
Asymmetry in the treatment of income and losses - ANSWERSthe government shares
in your income unconditionally and shares in your losses conditional on you having
taxable income in the future
Results in a profitable company spending pre tax dollars; a currently unprofitable (but
eventually profitable) company spending pretax dollars, with a tvm discount; and an
unprofitable company that will never be profitable spending after tax dollars
what restricts tax planning - ANSWERS1. business purpose
2. economic substance
3. substance over form
Suppose a taxpayer invests $100,000 in a partnership. Also assume that as was the
case in the 1970s, the taxpayer faces a personal tax rate of 70% and a tax rate on
capital gains of 28%. In the first year, the partnership spends the entire $100,000 on
research, which the taxpayer can claim as a deduction against her other income. In the
second year, the partnership sells the developed technology, and the taxpayer's share
of the sale price is $50,000, which is taxed as a capital gain. (Ignore the time value of
money in your answer.)
a. What is the pretax rate of return to the taxpayer?
b. what is the after tax rate of return to the taxpayer? - ANSWERSa. Investment =
100,000
End up with = 50,000
Return = 50,000-100,000=-50,000
Rate of return = return/investment = -50/100=-0.5
b. Investment = 30,000 (100,000*(1-0.7)=30,000)
End up with = 36,000 (50,000*(1-.28)=36,000 )
Return = 36,000-30,000=6,000
Rate of return = return/investment = 6/30=0.2
Trade offs in the treatment of losses - ANSWERS1. like profit - cut a check for rate *
loss
2. carry back and/or forward
3. carryback only (deduct against past income)
4. carryforward only (offset future income)
