Question

From a corporation’s point of view, does the tax treatment of dividends and interest paid favor the use of debt financing or equity financing?

Equity financing

Debt financing

Suppose a firm in the 40% federal-plus-state tax bracket needs to pay $1 in dividends to its shareholders. What is the pretax income it should have to pay this dividend?

$1.00

$1.67

Cute Camel Woodcraft Company owns 248,500 shares in the Lazy Zebra Furniture. If Lazy Zebra has 350,000 shares of common stock outstanding, can Cute Camel file a single income tax return that reports the incomes and expenses of both companies?

No, because Cute Camel Woodcraft Company’s ownership stake in Lazy Zebra is less than or equal to 40%, whereas 50% or more is required by the U.S. Tax Code.

No, because Cute Camel Woodcraft Company’s ownership stake in Lazy Zebra is less than or equal to 79%, whereas 80% or more is required by the U.S. Tax Code.

Yes, because Cute Camel Woodcraft Company’s ownership stake in Lazy Zebra is greater than or equal to 80%, as required by the U.S. Tax Code.

The Internal Revenue Service prohibits the improper   of dividends, which refers to a corporation’s retention of undistributed profits to assist shareholders in avoiding their personal income tax on dividends. The IRS imposes a penalty if corporations accumulate more than   .

Suppose you want to invest $10,000. You have two options:

	Option #1: Invest in municipal bonds with an expected return of 7.00%, or
	Option #2: Invest in the corporate bonds of Jefferson & Alexander Inc. which are offering an expected return of 8.75%

Assume that your decision is based solely on your tax situation. If everything else is the same for both bonds, at what tax rate would you be indifferent between these two bond investments?

18.60%

22.00%

20.00%

25.60%

For your personal portfolio, you purchased 1,000 shares of a foreign manufacturing company for $43.00 per share and sold it for $54.00 per share after 18 months. How will your gain or loss be treated when you file your taxes?

As a capital gain that will be taxed at the current ordinary income tax rate

As a capital gain that will be taxed at the capital gains tax rate

Answer 1

1. Debt Financing. From a corporation's point of view, does tax treatment of dividends and interest paid favor the use of debt financing Because Interest Paid is tax deductible and it favors corporation and on the other side Dividends are not tax deductible

2. Option B $1.67

Pre Tax Income = Dividends to be paid / (1 - tax Rate)

Pre Tax Income = $1.00 / (1 - 0.40)

Pre Tax Income = $1.67

3. Option B.

No, because Cute Camel Woodcraft Company’s ownership stake in Lazy Zebra is less than or equal to 79%, whereas 80% or more is required by the U.S. Tax Code.

Stake in Lazy Zebra Furniture = Shares Owned / Common Stock O/s

Stake in Lazy Zebra Furniture = 248500 / 350000

Stake in Lazy Zebra Furniture = 71%

4. $250000

The Internal Revenue Service prohibits the improper   of dividends, which refers to a corporation’s retention of undistributed profits to assist shareholders in avoiding their personal income tax on dividends. The IRS imposes a penalty if corporations accumulate more than   $250000.

5. Option C. 20%

Indifferent Interest Rate = Difference between Interest Rates / Corporation Interest Rate

Indifferent Interest Rate = 1.75% / 8.75% = 20%

6. Option B.

As a capital gain that will be taxed at the capital gains tax rate

As the Stock are held for more than 1 year, it is treated as Long Term Capital Asset and Gain is taxed at Capital gains Tax Rate.