Professional Documents
Culture Documents
Tax Planning Strategies and Related Limitations: 2020 Edition
Tax Planning Strategies and Related Limitations: 2020 Edition
Tax Planning Strategies and Related Limitations: 2020 Edition
2020 Edition
Chapter 3
Tax Planning
Strategies and Related
Limitations
©2020 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.
Learning Objectives 1
3-
©2020 McGraw-Hill Education
Learning Objectives 2
3-
©2020 McGraw-Hill Education
Basic Tax Planning Overview
Effective planning requires consideration of
both tax and nontax factors.
In general terms, effective tax planning
maximizes the taxpayer’s after-tax wealth
while achieving the taxpayer’s nontax goals.
Three parties to every transaction: taxpayer,
other transacting party, and the
government.
Three basic planning strategies: timing,
income shifting, and conversion.
3-
©2020 McGraw-Hill Education
Timing Strategies 1
3-
©2020 McGraw-Hill Education
Timing Strategies 2
3-
©2020 McGraw-Hill Education
Timing Strategies 3
3-
©2020 McGraw-Hill Education
Timing Strategies—Present Value
Example
At a recent holiday sale, Bill and Mercedes
purchased $1,000 worth of furniture with “no money
down and no payments for one year!” How much
money is this deal really worth? (Assume their after-
tax rate of return on investments is 10 percent.)
3-
©2020 McGraw-Hill Education
Timing Strategies 4
3-
©2020 McGraw-Hill Education
Timing Strategies Example 1
3-1
©2020 McGraw-Hill Education
Timing Strategies When Tax Rates
Change 1
3-1
©2020 McGraw-Hill Education
Timing Strategies When Tax Rates
Change 2
3-1
©2020 McGraw-Hill Education
Tax Rate Change
Having decided she needs new equipment for
her business, Mercedes is now considering
whether to make the purchase and claim a
corresponding $10,000 deduction at year-
end or next year. Mercedes anticipates that,
with the new machinery, her business
income will rise such that her marginal rate
will increase from 24 percent this year to 32
percent next year. Assuming her after-tax
rate of return is 8 percent, what should
Mercedes do?
3-1
©2020 McGraw-Hill Education
Tax Rate Change Solution
Mercedes should pay the $10,000 in January
Tax savings paid in December.
• $10,000 × 24% × 1 = $2,400.
Tax savings paid in January.
• $10,000 × 32% = $3,200.
• Discount savings back to current year.
• 3,200 × .826 = $2,963.
3-1
©2020 McGraw-Hill Education
Limitations to Timing Strategies
The tax deduction often cannot be accelerated
without also accelerating the actual cash outflow
that generates the deduction.
Tax law generally requires taxpayers to continue
their investment to defer income recognition.
A deferral strategy may not be optimal if taxpayer
has cash flow needs or if continuing the investment
generates low returns or subjects taxpayer to
unnecessary risk.
Constructive receipt doctrine: taxpayer must
recognize income when it is actually or
constructively received.
3-1
©2020 McGraw-Hill Education
Income-Shifting Strategies 1
3-1
©2020 McGraw-Hill Education
Income-Shifting Strategies 3
3-1
©2020 McGraw-Hill Education
Conversion Strategies 1
3-2
©2020 McGraw-Hill Education
Conversion Strategies 2
3-2
©2020 McGraw-Hill Education
Limitations of Conversion
Strategies
The Code itself contains provisions to
prevent a taxpayer from changing the
nature of expenses and income.
3-2
©2020 McGraw-Hill Education
Additional Limitations to Tax Planning
Strategies: Judicial Doctrines 1
Constructive Receipt (previously
discussed).
Assignment of income:
• Requires income to be taxed to the taxpayer who
actually earns the income.
• Merely attributing a paycheck or dividend to
another taxpayer does not transfer tax liability.
Related-party transactions:
• IRS scrutinizes these transactions because they
are often not arm’s length transactions.
3-2
©2020 McGraw-Hill Education
Additional Limitations to Tax Planning
Strategies: Judicial Doctrines 2
Business purpose doctrine:
• IRS has the power to disallow business expenses for
transactions that don’t have a business purpose.
Step-transaction doctrine:
• IRS has the power to collapse a series of transactions into
one to determine tax liability.
Substance-over-form doctrine:
• IRS can reclassify a transaction according to its substance
(instead of its form).
Economic substance doctrine:
• Transactions must meet two criteria.
1. Transaction must meaningfully change a taxpayer’s economic
position (excluding any federal income tax effects).
2. Taxpayer must have a substantial purpose (other than tax
avoidance) for the transaction.
3-2
©2020 McGraw-Hill Education
Tax Avoidance versus Tax Evasion 1
3-2
©2020 McGraw-Hill Education