Application Problem

1) Mrs. FB, who is in the 35 percent tax bracket, owns a residential apartment building that generates $80,000 of annual taxable income. She plans to create a family partnership by giving each of her two children a 20 percent equity in the building (she will retain a 60 percent interest.) Mrs. FB will manage the building and the value of her services is $15,000 per year. If Mrs. FBs children are in the 15 percent tax bracket, compute the tax savings from this income-shifting arrangement.

2)

Mr. P and Mrs. Q are equal shareholders in Corporation PQ. Both shareholders have a 35 percent marginal tax rate. PQs financial records show the following:

Gross Income from Sales of Goods	$880,000
Operating Expenses	(410,000)
Interest Paid on Debt to Mr. P and Mrs. Q	(62,000)
Dividend Distributions:
Mr. P	(50,000)
Mrs. Q	(50,000)

a) Compute the combined income tax cost for PQ, Mr. P, and Mrs. Q. (Remember that interest is deductible to the corporation and dividends are not. Also, remember that dividends would be taxed at a 15% rate to P and Q shareholders if they have a regular tax rate of 35%.)

b) How would your computation change if the interest on the shareholder debt was $162,000 and the corporation paid no dividends?

3)

Mr. Z is the sole shareholder of TZ. He also owns the office building that serves as corporate headquarters. Last year, TZ paid $180,000 annual rent to Mr. Z for the use of the building. TZs marginal tax rate was 34 percent and Mr. Zs marginal tax rate was 35 percent. The revenue agent who audited TZs return concluded that the fair rental value of the office building was $125,000.

a) By what amount is Mr. Zs tax liability reduced?

b) By what amount is corporation TZs tax increased?

4)

During a recent IRS audit, the revenue agent decided that the FP family used their closely held corporation, Falco, to avoid tax at the shareholder level by accumulating earnings beyond the reasonable needs of the business. Falcos taxable income was $900,000, it paid no dividends for the year, and it had no business need to retain any of this income. Compute Falcos accumulated earnings tax assuming that:

a) It had accumulated $4 million of after-tax income in prior years.

b) It had accumulated $129,000 after-tax income in prior years. (Remember you are allowed a $250,000 no questions asked accumulation.)