Question & Answer

Assume that in a household one parent currently works full time and the other stays at home to look after the family. How would you set about identifying and calculating the opportunity costs of the second parent now taking a full-time job? How would such calculations be relevant in deciding whether it is worth taking that job?

Imagine that you won millions of pounds on the National Lottery. Would your ‘economic problem’ be solved?

Imagine that a country can produce just two things: goods and services. Assume that over a given period it could produce any of the following combinations:                  

 (a)         Draw the country’s production possibility curve.

(b)         Assuming that the country is currently producing 40 units of goods and 70 units of services, what is the opportunity cost of producing another 10 units of goods?

 (c)         Explain how the figures illustrate the principle of increasing opportunity cost.

(d)         Now assume that technical progress leads to a 10 per cent increase in the output of goods for any given amount of resources. Draw the new production possibility curve. How has the opportunity cost of producing extra units of services altered?

Suppose you asked your favorite AI query tool “Is multijurisdictional tax-motivated income shifting an example of the conversion strategy?” and the AI tool responded as follows:

Is the AI response correct? Explain.

Suppose you asked your favorite AI query tool “Under the timing strategy, does it make sense for a person to accelerate income recognition when tax rates are increasing?” and the AI tool responded as follows:

Using the IRS Web site (https://www.irs.gov/pub/irs-pdf/p5869.pdf), how large is the current estimated “tax gap” (i.e., the amount of tax underpaid by taxpayers annually) for years 2020-2021? What group of taxpayers represents the largest “contributors” to the tax gap?

Jayanna, an advertising consultant, is contemplating instructing some of her clients to pay her in cash so that she does not have to report the income on her tax return. Use an available tax service to identify the three basic elements of tax evasion and penalties associated with tax evasion. Write a memo to Jayanna explaining tax evasion and the risks associated with her actions.  

Using an available tax service or the Internet, identify three basic tax planning ideas or tax tips suggested for year-end tax planning. Which basic tax strategy from this chapter does each planning idea employ?

Using the facts from the previous problem, how would your answer change if, instead, Duff adopted the cash method of accounting to allow them to better control the timing of their cash receipts and disbursements?

Duff is really interested in decreasing their tax liability and tends to be somewhat tax aggressive. A friend of a friend told Duff that cash transactions are more difficult for the IRS to identify and, thus, tax. Duff is contemplating using this “strategy” of not reporting cash collected in their business to minimize the tax liability. Is this tax planning? What are the risks with this strategy?

Alan inherited $100,000 with the stipulation that he “invest it to financially benefit his family.”  Alan and Alice decided they would invest the inheritance to help them accomplish two financial goals: purchasing a Park City vacation home and saving for their son Cooper’s education.

Alan and Alice have a marginal income tax rate of 32 percent (capital gains rate of 15 percent) and have decided to investigate the following investment opportunities.

Complete the two Annual After-Tax Rate of Return columns for each investment and provide investment recommendations for Alan and Alice.

Komiko Tanaka invests $12,000 in LymaBean, Inc. LymaBean does not pay any dividends. Komiko projects that her investment will generate a 10 percent before-tax rate of return. She plans to invest for the long term.

a) How much cash will Komiko retain, after-taxes, if she holds the investment for five years and then she sells it when the long-term capital gains rate is 15 percent?

b) What is Komiko’s after-tax rate of return on her investment in part (a)?

c) How much cash will Komiko retain, after-taxes, if she holds the investment for five years and then sells when the long-term capital gains rate is 25 percent?

d) What is Komiko’s after-tax rate of return on her investment in part (c)?

e) How much cash will Komiko retain, after taxes, if she holds the investment for 15 years and then she sells when the long-term capital gains rate is 15 percent?

f) What is Komiko’s after-tax rate of return on her investment in part (e)?

Irene is saving for a new car she hopes to purchase either four or six years from now. Irene invests $10,000 in a growth stock that does not pay dividends and expects a 6 percent annual before-tax return (the investment is tax deferred). When she cashes in the investment after either four or six years, she expects the applicable marginal tax rate on long-term capital gains to be 25 percent. 

a) What will be the value of this investment four years from now? Six years from now?

b) When Irene sells the investment, how much cash will she have after taxes to purchase the new car (four and six years from now)?

Anne’s marginal income tax rate is 32 percent. She purchases a corporate bond for $10,000 and the maturity, or face value, of the bond is $10,000. If the bond pays 5 percent per year before taxes, what is Anne’s annual after-tax rate of return from the bond if the bond matures in one year? What is her annual after-tax rate of return if the bond matures in 10 years?

Helen holds 1,000 shares of Fizbo Inc. stock that she purchased 11 months ago. The stock has done very well and has appreciated $20/share since Helen bought the stock. When sold, the stock will be taxed at capital gains rates (long-term rate is 15% and short-term rate is the taxpayer’s marginal tax rate). If Helen’s marginal tax rate is 35 percent, how much would she save by holding the stock an additional month before selling? What might prevent Helen from waiting to sell? Ignore the time value of money.

Hui is currently considering investing in municipal bonds that earn 6 percent interest, or in taxable bonds issued by the Coca-Cola Company that pay 8 percent. If Hui’s tax rate is 22 percent, which bond should Hui choose? Which bond should Hui choose if the rate is 32 percent? At what tax rate would Hui be indifferent between the bonds? What strategy is this decision based upon?

Daniel is considering selling two stocks that have not performed well over recent years. A friend recently informed Daniel that one of his stocks has a special designation, which allows him to treat a loss up to $50,000 on this stock as an ordinary loss rather than the typical capital loss. Daniel figures that he has a loss of $60,000 on each stock. If Daniel’s marginal tax rate is 35 percent and he has $120,000 of other capital gains (taxed at 15 percent), what is the tax savings from the special tax treatment?

Using the facts in the previous problem, what are some ways that Bendetta could shift some of the rental income to Jenine? What are the disadvantages associated with these income-shifting strategies?

Bendetta, a high-tax-rate taxpayer, owns several rental properties and would like to shift some income to her daughter, Jenine. Bendetta instructs her tenants to send their rent checks to Jenine so Jenine can report the rental income. Will this shift the income from Bendetta to Jenine? Why or why not?  

Hyundai is considering opening a plant in two neighboring states. One state has a corporate tax rate of 10 percent. If operated in this state, the plant is expected to generate $1,000,000 pretax profit. The other state has a corporate tax rate of 2 percent. If operated in this state, the plant is expected to generate $930,000 of pretax profit. Which state should Hyundai choose? Why do you think the plant in the state with a lower tax rate would produce a lower before-tax income? 

} Orie and Jane, husband and wife, operate a sole proprietorship. They expect their taxable income next year to be $450,000, of which $250,000 is attributed to the sole proprietorship. Orie and Jane are contemplating incorporating their sole proprietorship. Using the married-joint tax brackets and the corporate tax rate in Appendix C, find out how much current tax this strategy could save Orie and Jane. How much income should be left in the corporation?

Moana is a single taxpayer who operates a sole proprietorship. She expects her taxable income next year to be $250,000, of which $200,000 is attributed to her sole proprietorship. Moana is contemplating incorporating her sole proprietorship. Using the single individual tax brackets and the corporate tax rate in Appendix C, find out how much current tax this strategy could save Moana (ignore any Social Security, Medicare, or self-employment tax issues). How much income should be left in the corporation?

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? 

b. How much pretax income does it currently take Tawana to generate the $8,000 (after taxes) given to Jonathon? 

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)? 

d. How much money would the strategy in part (c) save?  

Bob’s Lottery, Inc. has decided to offer winners a choice of $100,000 in 10 years or some amount currently. Assume that Bob’s Lottery Inc. earns a 10 percent after-tax rate of return. What amount should Bob’s offer lottery winners currently to be indifferent between the two choices?

Jonah has the choice of paying Rita $10,000 today or $40,000 in ten years. Assume Jonah can earn a 12 percent after-tax rate of return. Which should he choose?