Taxes and Business Strategy : A Planning Approach

by Scholes, Myron S.; Wolfson, Mark A.; Erickson, Merle M.; Maydew, Edward L.; Shevlin, Terry J.

• ISBN13: 9780130253989
• ISBN10: 0130253987
• Format: Hardcover
• Copyright: 2002-01-01
• Publisher: Pearson College Div

Summary

This book takes an MBA style strategy perspective by considering the tax, accounting, and finance trade-offs involved in tax planning. Reflected in this revision are all changes in the tax code. Also covered: extensive analysis of technical tax rules applied to corporate mergers and acquisitions; explanation of accounting for income taxes; discussion on College Savings Plans (529s); up-to-date material on new tax rates on dividends and capital gains; and much more. For individuals furthering their personal or formal education of tax strategy, investment banking, corporate finance, strategy consulting, money management, or venture capital.

Table of Contents

Introduction to Tax Strategy	1	(18)
Why Do Tax Rules Influence Investment Decisions?	2	(1)
Structure and Themes of This Text	2	(6)
A planning approach	3	(1)
Taxing authority as investment partner	3	(2)
The importance of a contractual perspective	5	(1)
Implicit taxes and tax clienteles	6	(1)
Tax planning as a tax-favored activity	6	(1)
Why study tax planning?	7	(1)
Topics Covered in This Text	8	(2)
Intended Audience for This Text	10	(9)
Summary of Key Points	12	(2)
Overview of Calculating Income Tax Liability	14	(2)
Discussion Questions	16	(1)
Exercises	16	(1)
Tax Planning Problems	17	(1)
References and Additional Readings	18	(1)
Tax Law Fundamentals	19	(22)
Types of Tax Planning	21	(4)
Converting income from one type to another	21	(2)
Shifting income from one pocket to another	23	(1)
Shifting income from one time period to another	23	(2)
Restrictions on Taxpayer Behavior	25	(4)
Constructive-receipt doctrine	25	(1)
Substance-over-form and business-purpose doctrines	25	(3)
Related-party versus arm's-length contracts	28	(1)
Assignment-of-income doctrine	28	(1)
The Legislative Process and Sources of Tax Information	29	(12)
Primary authorities	29	(1)
The legislative process	30	(1)
Regulations and revenue rulings that result from the passage of a tax act	31	(1)
The role of judicial decisions	32	(1)
Secondary authorities	32	(1)
Summary of Key Points	33	(1)
Sources of Information on Tax Legislation	34	(1)
Discussion Questions	35	(1)
Exercises	36	(1)
Tax Planning Problems	37	(2)
References and Additional Readings	39	(2)
Returns to Alternative Savings Vehicles	41	(21)
Intertemporally Constant Tax Rates	42	(9)
Review of compound interest	44	(1)
Investments in savings vehicles I and II	45	(2)
Hybrid savings vehicles	47	(1)
Differences in after-tax accumulations in savings vehicles I and II as a function of pretax rates of return	47	(1)
Investments in savings vehicle III	47	(1)
Comparison of savings vehicles II and III	48	(1)
Investments in savings vehicle IV	49	(1)
Investments in savings vehicle V	49	(1)
Investments in savings vehicle VI	50	(1)
Dominance relations and empirical anomalies	50	(1)
Changes in Tax Rates over Time	51	(1)
More on Pension Plans	52	(10)
Traditional deductible IRAs	53	(1)
Roth IRAs	53	(1)
Nondeductible IRAs	53	(1)
Comparison of the deductible and Roth IRAs: New contributions	53	(2)
Comparison of the deductible and Roth IRAs: The rollover decision	55	(1)
Summary of Key Points	56	(1)
Discussion Questions	57	(1)
Exercises	58	(2)
Tax Planning Problems	60	(1)
Reference	61	(1)
Choosing the Optimal Organizational Form	62	(29)
Organizational Forms for Producing Goods and Services	64	(4)
After-tax returns to pass-through and non-pass-through forms of organization	66	(2)
The Choice of Partnership or Corporate Form in Special Cases	68	(1)
Changing Preferences for Organizational Forms Induced by Tax-Rule Changes	68	(11)
The required before-tax rates of return on corporate and partnership activities	69	(2)
The required rate of return on stocks in the presence of dividends	71	(1)
The effective annualized tax rate on shares	72	(1)
Required before-tax rate of return: Corporations versus partnerships	72	(2)
Pre-1981 Economic Recovery Tax Act (ERTA 1981)	74	(1)
Post-1981 Economic Recovery Tax Act (1981--1986)	74	(1)
Post-1986 Tax Reform Act (1987, 1988--1990)	74	(1)
Post-1999 Revenue Reconciliation Tax Acts (1991--1996)	75	(1)
1997 to the present	75	(1)
Cross-sectional variation in corporate, personal and, shareholder-level tax rates	76	(1)
Net operating losses and the corporate tax rate	76	(1)
Further complications in determining the shareholder-level tax rate, ts	77	(2)
Progressive personal income tax rates, tp and tcg	79	(1)
Other Organizational Forms for Organizing Production Activities	79	(5)
Hybrid corporate forms	79	(4)
Other noncorporate organizational forms	83	(1)
Nontax Advantages of Operating in Corporate Form	84	(7)
Summary of Key Points	85	(1)
Discussion Questions	86	(1)
Exercises	87	(1)
Tax Planning Problems	88	(2)
References and Additional Readings	90	(1)
Implict Tax and Clienteles, Arbitrage, Restrictions and, Frictions	91	(36)
Tax-Favored Status and Implicit Taxes	93	(5)
The Implicit Tax Rate, the Explicit Tax Rate and, the Total Tax Rate	98	(2)
Computing the implicit tax	98	(1)
Total tax rates in a competitive market	99	(1)
The Importance of Adjusting for Risk Differences	100	(3)
Clienteles	103	(2)
Evidence on the existence of implicit taxes and clienteles	104	(1)
Implicit Taxes and Corporate Tax Burdens	105	(2)
Tax Arbitrage	107	(1)
Organizational-Form Arbitrage	107	(8)
Immediate tax rebates when taxable income is negative	107	(1)
No tax rebates on negative taxable income	108	(1)
Restrictions on organizational-form arbitrage	109	(1)
Full taxation with deferral and organizational-form arbitrage	110	(1)
The effects of frictions on organizational-form arbitrage	111	(1)
Bankruptcy rules and organizational-form arbitrage	112	(1)
Buying and selling implicitly taxed assets to effect organizational-form arbitrage	113	(2)
Clientele-Based Arbitrage	115	(12)
Clientele-based arbitrage with investments in tax-favored assets other than tax-exempt bonds	116	(1)
Market equilibrium with tax-exempt entities	117	(1)
Summary of Key Points	117	(3)
Adjusting for Risk Using the Capital Asset Pricing Model	120	(1)
Discussion Questions	120	(1)
Exercises	121	(2)
Tax Planning Problems	123	(2)
References and Additional Readings	125	(2)
Nontax Costs of Tax Planning	127	(28)
Symmetric Uncertainty, Progressive Tax Rates and, Risk Taking	129	(4)
R&D and O&G activities	131	(2)
Progressive tax rates and hedging	133	(1)
Tax Planning in the Presence of Risk-Sharing and Hidden-Action Considerations	133	(5)
Contracting in capital markets	133	(2)
Contracting in labor markets	135	(1)
Conflicts between risk sharing and tax minimization	136	(1)
Conflicts between incentive contracting and tax minimization	137	(1)
Tax Planning in the Presence of Hidden-Information Considerations	138	(1)
Tax Planning and Organizational Design	139	(2)
Conflicts Between Financial Reporting and Tax Planning	141	(14)
Income Shifting Across Time	142	(1)
LIFO/FIFO studies	143	(1)
LIFO adoption	143	(1)
LIFO liquidation	143	(1)
LIFO abandonment	144	(1)
Regulatory costs	144	(1)
Asset sales and divestitures	145	(1)
Dollar estimates of firms' willingness to forego tax savings	145	(1)
Political cost impediments to tax planning	146	(1)
Other book-tax conformity costs	146	(1)
Other informational cost impediments to tax planning	147	(1)
Summary of Key Points	147	(2)
Discussion Questions	149	(1)
Exercises	150	(2)
Tax Planning Problems	152	(1)
References and Additional Readings	153	(2)
The Importance of Marginal Tax Rates and Dynamic Tax-Planning Considerations	155	(25)
Marginal Tax Rate: Definitional Issues	157	(6)
Foreign, state and, local corporate taxes	159	(1)
Individual taxpayers' marginal tax rate	160	(1)
Average and effective tax rates	161	(1)
Problems with effective tax rates	161	(2)
Tax Planning for Low Marginal Tax Rate Firms	163	(1)
Adaptability of Tax Plans	164	(3)
Transaction costs and tax clienteles	165	(1)
Adaptability in investment and financing decisions	166	(1)
Reversibility of Tax Plans	167	(1)
Ability to Insure Against Adverse Changes in Tax Status	168	(4)
Tax Planning When a Taxpayer's Marginal Tax Rate Is Strategy-Dependent	172	(8)
Summary of Key Points	173	(2)
Medical Savings Plans and Dynamic Tax Planning	175	(1)
Discussion Questions	175	(1)
Exercises	176	(2)
Tax Planning Problems	178	(1)
References and Additional Readings	179	(1)
Compensation Planning	180	(31)
Salary Versus Deferred Compensation	181	(4)
Employer and employee tax rates both expected to fall	184	(1)
Salary Versus Fringe Benefits	185	(3)
Analysis for taxable employer	187	(1)
Analysis for tax-exempt employer	187	(1)
Compensatory Loans	188	(1)
Cash Bonus Plans	189	(1)
Stock-Based Compensation Components	190	(21)
Tax issues relating to incentive stock options and nonqualified stock options	191	(4)
Evidence on the role of taxes in the choice of ISO	195	(1)
Disqualifying dispositions of ISOs	195	(2)
The role of taxes in the NQO exercise decision	197	(3)
Financial accounting and tax comparison of stock appreciation rights and stock options	200	(2)
Compensation in venture-capital-backed start-ups	202	(1)
Other influences of taxes on compensation structure	202	(1)
Concluding remarks	203	(1)
Summary of Key Points	204	(1)
Discussion Questions	205	(1)
Exercises	206	(2)
Tax Planning Problems	208	(2)
References and Additional Readings	210	(1)
Pension and Retirement Planning	211	(29)
Types of Pension Plans	212	(2)
Comparison of Salary and Pension Compensation	214	(3)
Rates of return on investments in and out of pension accounts	216	(1)
Antidiscrimination rules	216	(1)
Deferred Compensation Versus Pension	217	(1)
The Stocks-Versus-Bonds Puzzle	218	(4)
Does It Pay to Maintain an Overfunded Pension Plan?	222	(4)
Advantages and disadvantages	222	(3)
Empirical evidence on determinants of defined benefit plan pension funding	225	(1)
Funding Post-Employment Health Care Benefits	226	(4)
The sweetened pension benefit approach	227	(1)
The pay-as-you-go approach	228	(1)
Other factors relevant to the funding decision	229	(1)
Employee Stock Ownership Programs	230	(10)
Summary of Key Points	232	(2)
Excise Tax Complications	234	(1)
Discussion Questions	235	(1)
Exercises	235	(1)
Tax Planning Problems	236	(3)
References and Additional Readings	239	(1)
Multinational Tax Planning: Introduction and Investment Decisions	240	(31)
Overview of Multinational Taxation	242	(10)
Avoiding worldwide taxation	243	(1)
Operating as a branch versus a foreign subsidiary	243	(3)
Foreign tax credits	246	(3)
Subpart F income and controlled foreign corporations (CFCs)	249	(2)
Inversion transactions	251	(1)
How Taxes Affect the Location and Structure of Investments	252	(6)
Large implicit taxes and foreign investment incentives	256	(2)
The Decision to Repatriate or Reinvest	258	(13)
Subpart F income and controlled foreign corporations	260	(1)
Investment and repatriation policy when the foreign tax rate exceeds the domestic tax rate	261	(1)
Summary of Key Points	262	(1)
Discussion Questions	262	(1)
Exercises	263	(1)
Tax Planning Problems	264	(5)
References and Additional Readings	269	(2)
Multinational Tax Planning: Foreign Tax Credit Limitations and Income Shifting	271	(20)
Foreign Tax Credit Limitations and Incentives	272	(7)
Example of excess FTC limitation	272	(2)
Examle of excess FTC credit	274	(2)
Example of FTC with multiple subsidiaries	276	(1)
Country-by-country FTC limitations	277	(1)
Separate basket limitations	277	(2)
FTC limitations and the capital structure of foreign subsidiaries	279	(1)
Shifting Income Across Jurisdictions	279	(4)
Transfer pricing	279	(1)
Source of income rules	280	(3)
Loss importation transactions	283	(1)
U.S. Tax Treatment of Foreign Investors	283	(8)
Summary of Key Points	284	(1)
Discussion Questions	285	(1)
Exercises	286	(1)
Tax Planning Problems	287	(2)
References and Additional Readings	289	(2)
Corporations: Formation, Operation, Capital Structure and, Liquidation	291	(26)
Corporate Formation	292	(2)
Taxation of Corporate Operations	294	(3)
Book-Tax Differences: Taxable Income Versus GAAP Income	294	(1)
Net operating losses	295	(1)
Gains and lossesand tax basis	295	(1)
Capital gains and losses	296	(1)
Section 1231 assets	296	(1)
Dividends-received deduction	297	(1)
Consolidated tax returns	297	(1)
Possible Tax Benefits of Leverage in Firms' Capital Structures	297	(3)
Theory of the tax benefits of leverage	298	(2)
Empirical work on the tax benefits of leverage	300	(1)
Debt-Equity Hybrids	300	(6)
``Plain-vanilla'' preferred stock	301	(1)
Trust preferred stock	301	(3)
Zero-coupon bonds	304	(2)
Taxation of Distributions and Share Repurchases	306	(5)
The concept of earnings and profits	307	(2)
Special kinds of distributions	309	(1)
Taxation of share repurchases	310	(1)
Tax Planning Using the Tax Rules for Distributions and Share Repurchases	311	(1)
Taxation of Liquidations	312	(5)
Parent-Subsidiary Liquidations	312	(1)
Summary of Key Points	312	(1)
Discussion Questions	313	(1)
Exercises	314	(1)
References and Additional Readings	315	(2)
Introduction to Mergers, Acquisitions and, Divestitures	317	(17)
Overview of Issues	318	(2)
Reasons for mergers, acquisitions and, divestitures	318	(1)
Types of mergers, acquisitions and, divestitures	319	(1)
Major Tax Issues Associated With Mergers, Acquisitions and, Divestitures	320	(3)
Shareholder tax liabilities	320	(1)
Effect on tax attributes	321	(1)
Target corporate-level tax effect of the merger, acquisition, or divestiture	322	(1)
Change in the tax basis of the target or divested subsidiary assets	322	(1)
Effect of leverage on mergers and acquisitions	323	(1)
Nontax Issues in Mergers, Acquisitions and, Divestitures	323	(1)
Five Basic Methods to Acquire a Freestanding C Corporation	324	(1)
Four Methods to Divest a Subsidiary or Line of Business	325	(2)
Tax Deductibility of Goodwill and Other Intangible Assets Under Section 197	327	(7)
Summary of Key Points	330	(2)
Discussion Questions	332	(1)
References and Additional Readings	332	(2)
Taxable Acquisitions of Freestanding C Corporations	334	(27)
Tax Consequences of Alternative Forms of Corporate Acquisitions	335	(10)
Taxable asset acquisition without a complete liquidation of the target	337	(2)
Sale of the target firm's assets followed by a liquidation	339	(1)
Purchase of the target's stock followed by a section Election	340	(3)
Purchase of the target's stock without a section 338 election	343	(2)
Comparison of Taxable Acquisition Structures	345	(6)
Analysis of acquiring firm indifference price	349	(2)
Tax Deferral through Installment Sale Tax Treatment	351	(1)
Practical Issues Associated with Structuring and Pricing an Acquisition	351	(10)
Estimating the net tax basis of a target's assets	352	(6)
Summary of Key Points	358	(1)
Discussion Questions	358	(1)
Tax Planning Problems	359	(1)
References and Additional Readings	360	(1)
Taxable Acquisitions of S Corporations	361	(27)
Tax Consequences of Taxable S Corporation Acquisition Structures	362	(16)
Taxable asset acquisition	364	(4)
Taxable stock acquisition with section 338(h)(10) election	368	(2)
Taxable stock acquisition without a section 338(h)(10) election	370	(1)
Which structure is optimal in the sale of an S corporation?	371	(2)
Advanced analysis: S corporation acquisition	373	(5)
Comparison of the Sale of Similar S and C Corporations	378	(10)
Tax consequences for T1 and T2 shareholders in a taxable stock sale	379	(1)
Tax consequences for A corporation	379	(1)
Indifference point for T1's shareholders (C corporation) with an asset sale structure	379	(1)
Indifferent price for T2's shareholders (S corporation) with an asset sale structure	379	(3)
Will the acquirer pay T1's (C corporation) indifference price in a taxable asset sale?	382	(1)
Will the acquirer pay T2's (S corporation) indifference price in a taxable asset sale (stock sale with a Section 338(h)(10) election)?	382	(1)
Valuation consequences and issues	383	(1)
Installment sales tax treatment	384	(1)
Summary of Key Points	384	(1)
Discussion Questions	385	(1)
Tax Planning Problems	385	(2)
References and Additional Readings	387	(1)
Tax-Free Acquisitions of Freestanding C Corporations	388	(41)
Basic Types of Tax-Free Reorganizations	389	(2)
General requirements for tax-free treatment under Section 368	389	(2)
Section 368 ``A'' Reorganization: Statutory Merger	391	(4)
Requirements to qualify for tax-free treatment under Section 368(a)(1)(A)	391	(1)
Tax consequences of a Section 368 ``A''	391	(3)
Nontax issues associated with the Section 368 ``A'' structure	394	(1)
Triangular mergers	395	(1)
Section 368 ``B'' Reorganization: Stock for Stock Acquisition	395	(3)
Requirements to qualify for tax-free treatment under Section 368(a)(1)(B)	395	(2)
Tax consequences of a Section 368 ``B''	397	(1)
Nontax issues associated with the Section 368 ``B'' structure	398	(1)
Section 368 ``C'' Reorganization: Stock for Assets Acquisition	398	(2)
Requirements to qualify for tax-free treatment under Section 368(a)(1)(C)	399	(1)
Tax consequences of a Section 368``C''	400	(1)
Tax-Free Reorganizations Under Section 351	400	(5)
Requirements for tax-free treatment under Section 351	401	(1)
Tax consequences of a Section 351 merger	401	(3)
Comparison of tax-free acquisition structures	404	(1)
Limitations on Target Firm Tax Attributes	405	(4)
Limitations on acquiring firm tax attributes	408	(1)
Taking advantage of expiring NOLs: Sale/leaseback	409	(1)
Quantifying Pricing Differences Between Taxable and Tax-Free Acquisitions of Freestanding C Corporations	409	(10)
Additional complexities	414	(2)
Implications for corporate valuation	416	(2)
Trends in acquisition volume and structure across time	418	(1)
Comparison of Taxable and Tax-Free Acquisitions of Freestanding C Corporations	419	(10)
Advanced techniques to provide diversification and tax-free treatment	422	(1)
Summary of Key Points	423	(1)
Discussion Questions	423	(1)
Tax Planning Problems	424	(4)
References and Additional Readings	428	(1)
Tax Planning for Divestitures	429	(34)
Subsidiary Sales	430	(16)
Tax-free subsidiary sales	430	(2)
Taxable subsidiary sales	432	(6)
Comparison of taxable acquisition structures	438	(5)
Additional complexities: Subsidiary sale	443	(2)
Difference between subsidiary sales and sales of freestanding C corporations	445	(1)
Valuation effects	446	(1)
Tax-Free Divestiture Methods	446	(7)
Equity carve-outs	446	(2)
Tax-free spin-offs	448	(4)
Other variants of the spin-off: Split-ups, split-offs and, tracking stock	452	(1)
Factors that influence divestiture method choice	453	(1)
Advanced Divestiture Techniques	453	(10)
Tax-free subsidiary sale under Section 351 followed by secured borrowing	453	(2)
Derivative-based divestiture techniques	455	(2)
Summary of Key Points	457	(1)
Discussion Questions	458	(1)
Tax Planning Problems	458	(4)
References and Additional Readings	462	(1)
Estate and Gift Tax Planning	463	(28)
Fundamentals of Estate and Gift Taxation	465	(6)
Specifics of the gift tax	467	(1)
Specifics of the estate tax	468	(3)
Generation-skipping transfer tax	471	(1)
Estate and Gift Planning Strategies	471	(7)
Making full use of the annual gift tax exclusion	471	(1)
Gifting in excess of the annual exclusion	472	(1)
Using each spouse's unified credit and lower brackets	473	(1)
Using the marriage deduction to defer estate taxation	473	(1)
Keeping life insurance out of the gross estate	474	(1)
Family limited partnerships	475	(1)
Transfer of knowledge, information and, services	476	(1)
Charitable remainder trusts	476	(1)
Grantor retained trusts	477	(1)
Monetizing Appreciated Assets Without Triggering Taxation: A Case Study	478	(4)
Taxation of short sales	479	(1)
The strategy	480	(1)
Congress takes action	481	(1)
Avoiding the constructive sale rules	481	(1)
The Tax Subsidy to Charitable Giving	482	(1)
A Model of the Trade-Offs Between Gifting Now Versus by Bequest	483	(2)
The trade-offs between gifting and losing the step-up in basis on bequests	484	(1)
International Aspects of Estate and Gift Taxation	485	(6)
Summary of Key Points	486	(1)
Discussion Questions	487	(1)
Exercises	487	(1)
Tax Planning Problems	488	(1)
References and Additional Readings	489	(2)
Glossary	491	(16)
Index	507