Chapter 3 - tax planning strategies PDF

Preview

Summary

Professor Jay Wright, Lecture 3 notes, contains bulleted list of important topics covered....

Description

Chapter 3: tax planning strategies  Effective tax planning maximizes the taxpayers after tax wealth while achieving the taxpayers nontax goals.  Maximizing after tax wealth requires us to consider both the tax and nontax costs and benefits of alternative transactions.  Three basic tax planning strategies (building blocks of tax planning):::: timing- deferring or accelerating taxable income and tax deductions. Income shifting- shifting income from high to low rate taxpayers. Conversion- converting income from high to low tax rate activities.  Present value- $1 received today is worth more than $1 received in the future, time value of money.  After tax rate of return- a taxpayers before tax rate of return on an investment minus the taxes paid on the income from the investment.  Taxes paid = cash outflows  Tax savings (generated from tax deductions) = cash inflows.  Two tax related timing strategies when tax rates are constant: accelerate tax deductions, defer recognizing taxable income.  Generally, whenever a taxpayer can accelerate a deduction without also substantially accelerating the cash outflow, the timing strategy will be more beneficial.  Common examples of accelerating a deduction is using LIFO instead of FIFO  The higher the tax rate the higher the savings for a tax deduction. The lower the tax rate the lower the tax costs for taxable income.  All else being equal, taxpayers should prefer to recognize deductions during high tax rate years and income during low tax rate years.  Tax rates can vary across taxpayers or jurisdictions  Income shifting (shifting from high tax rate taxpayers to low tax rate taxpayers) benefits: related parties, family or businesses, and taxpayers operating in multiple jurisdictions with different marginal tax rates.  Assignment of income doctrine- requires income to be taxed to the taxpayer who actually earns it  Related party transactions- financial activities among family members  Arms length transactions- each transacting party negotiates for their own benefit.  Limitations of income shifting across jurisdictions::::: taxing authorities are fully aware of the tax benefits of strategically structuring transactions across tax borders, so the IRS is watching. When taxpayers locate in low tax rate jurisdictions to shift income, they may bear implicit taxes (additional costs attributable to the jurisdictions tax advantage). Also negative publicity from moving operations from the United states to a lower tax place may be harmful to the business.  Expenses from different activities are treated differently for tax purposes (ex. Business garbage may be deductible but personal garbage is not) After tax rate of return = before tax rate of return – (before tax rate of return * marginal tax rate)

OR ^^^^ after tax rate of return = before tax rate of return * (1-marginal tax rate)  Implicit taxes may reduce or eliminate the advantages of tax preferred investments.  Business purpose doctrine- allow the IRS to challenge and disallow business expenses for transactions with no underlying business motivation  Step transaction doctrine- allows the IRS to collapse a series of related transactions into one transaction to determine the tax consequences of the transaction  Substance over form doctrine- allows the RIS to consider the transactions substance regardless of its form  Economic substance doctrine- requires transactions to meet two criteria to obtain tax benefits  Tax avoidance- legal act of arranging your transactions to minimize taxes paid  Tax evasion- willful attempt to defraud the government by not paying taxes that are legal owed...