TAX4001 – Week 3 Writing Assignment – Part 3
You are a manager at a local accounting firm, and Kate and Sam Smith are your clients. It is the end of the year, and they have come to ask your advice on some tax planning strategies, as well as help preparing their tax return.
Write a 4-page letter to Kate and Sam Smith which:
Walks them through their current year tax return.
Detail which expenses they incurred that were nondeductible for tax purposes and explain why. The Smiths have always itemized deductions instead of taking the standard deduction on their tax return. Explain how this may no longer be the best tax strategy due to changes in tax law under the TCJA.
Regarding the investment opportunities you calculated in week 1, explain:
Which investment opportunity you would recommend.
What the conversion tax planning strategy is, and which of these investments employ this strategy.
How “implicit taxes” may limit the benefits of the conversion strategy.
Kate and Sam are considering purchasing a vacation home. They plan on spending several months each year vacationing in the home and renting out the property the rest of the year. Provide an overview of the key tax considerations they should take into account when making this decision.Sheet1
Name:
Kate and Sam Smith Investment Opportunities
Here are the three different investment opportunities you have identified for the Smiths, all with the same amount of risk: Amount Inherited to Kate and Sam Smith $200,000
1. Taxable corporate bonds that pay 4.75 percent interest annually. Tax Rate 30%
2. A high-dividend stock that pays 4 percent dividends annually but has no appreciation potential. Capital Gain Tax Rate 15%
3. Tax-exempt municipal bonds that pay 3.5 percent annually.
Kate and Sam have a marginal tax rate of 30 percent (capital gains rate of 15 percent).
Investment Choice Computation After-Tax Return
1. Corporate Bond $200,000*4.75%*(1-0.30) $6,650
2. High-dividend stock $200,000*4%*(1-0.15) $6,800
3. Municipal bond $200,000*3.5% $7,000
Here are the three basic tax planning strategies, and the features of taxation each of them exploits:
Since the third investment option is generating more after tax returns, therefore, tax-exemption municipal boonds that pay 3.5% annually is the optimal investment option out of the three options.
The Timing strategy exploits the variation in taxation across time, for example the “real” tax costs of income decrease as taxation is deferred; the “real” tax savings associated with tax deductions increase as tax deductions are accelerated.
The income-shifting strategy exploits the variation in taxation across taxpayers. This strategy utilizes the differences in taxation that prevails across every taxpayer.
And finally, the conversion strategy exploits the variation in taxation across all activities.
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