efif th taxes and business strategy

Scholes • Wolfson • Erickson

Hanlon • M

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ntaxes and Business Strategy

A Planning Approach

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Table of Contents

Cover��

Title��

Copyright��

Contents��

Preface��

Acknowledgments��

About the Authors��

Chapter 1 Introduction to TaxStrategy��

1.1 Themes of the Book��Taxing Authority as Investment

Partner��

The Importance of a Contractual

Perspective��

1.2 Why Do Tax Rules Influence Before-Tax Rates of Return and InvestmentDecisions?

Implicit Taxes and Tax Clienteles��

Tax Planning as a Tax-Favored

Activity��

Why Study Tax Planning?��

1.3 Topics Covered in This Book��

1.4 Intended Audience for This Book��

Summary of Key Points��

Appendix 1.1 Overview of Calculation of U.S. Income TaxLiability��

Discussion Questions��

Exercises��

Tax-Planning Problems��

References��

Chapter 2 Tax-Planning Fundamentals��2.1 Types of Income Tax Planning��

Converting Income from One Type to

Another��

Shifting Income from One Pocket to

Another��

Shifting Income from One Time Period to

Table of Contents

Another��2.2 Restrictions on TaxpayerBehavior��

Economic Substance, Business Purpose, and Substance over Form

Constructive-Receipt Doctrine��

Related-Party versus Arms-Length

Contracts��

Assignment-of-Income Doctrine��

2.3 The Legislative Process and Sources of TaxInformation��

Primary and Secondary Authorities��

The Legislative Process��

Regulations and Revenue Rulings That Result from the Passage of a Tax Act

The Role of Judicial Decisions��

Secondary Authorities��


Appendix 2.1 Sources of Information on TaxLegislation��

Appendix 2.2 More Detailed Examples of TaxPlanning��


Exercises��


References and Additional Readings��

Chapter 3 Returns on Alternative SavingsVehicles��

3.1 Intertemporally Constant TaxRates��

Review of Compound Interest��

Investments in Savings Vehicles I and

II��

Hybrid Savings Vehicles��

Differences in After-Tax Accumulations in Savings Vehicles I and II as a

Function of Pretax Rates of Return

Investments in Savings Vehicle III��

Comparison of Savings Vehicles II and

III��

Investments in Savings Vehicle IV��

Investments in Savings Vehicle V��

Investments in Savings Vehicle VI��

Dominance Relations and Empirical

Table of Contents

Anomalies��3.2 Changes in Tax Rates over Time��

3.3 More on Pension Plans��Traditional Deductible IRAs��

Nondeductible IRAs��

Roth IRAs��

Comparison of the Deductible and Roth IRAs—New

Contributions��

Comparison of the Deductible and Roth IRAsThe Conversion Decision



Exercises��



Chapter 4 Choosing the Optimal OrganizationalForm��

4.1 Organizational Forms for Producing Goods andServices��

Data on Partnerships and LLCs��

Data on Corporations��

4.2 Computation of After-Tax Returns to Pass-Through and Non-Pass-Through Formsof Organization

4.3 Start-up Enterprises: Decision Factors, Expectations, and ObservedData��

4.4 Changing Preferences for Organizational Forms Induced by Tax-RuleChanges��

The Required Before-Tax Rates of Return on Corporate and Partnership Activities

The Required Rate of Return on Stocks in the Presence of

Dividends��

The Effective Annualized Tax Rate on Shares: ts

Required Before-Tax Rate of Return: Corporations versus Partnerships: R*c

Post-1986 Tax Reform Act (1987, 19881990)

Further Analysis of the 2003 Tax Act

Progressive Personal Income Tax Rates, tp and

tcg��

4.5 Other Organizational Forms Through Which to Organize Production Activities


Appendix 4.1 Dividend Imputation in the CorporateForm��

Appendix 4.2 Other Investment

Table of Contents

Vehicles��Discussion Questions��

Exercises��



Chapter 5 Implicit Taxes and Clienteles, Arbitrage, Restrictions, andFrictions��

5.1 Tax-Favored Status and ImplicitTaxes��

5.2 The Implicit Tax Rate, the Explicit Tax Rate, and the Total Tax Rate Computing the Implicit Tax��

Total Tax Rates in a Competitive

Market��

5.3 The Importance of Adjusting for RiskDifferences��

5.4 Clienteles��Evidence on the Existence of Implicit Taxes and

Clienteles��

5.5 Implicit Taxes and Corporate TaxBurdens��

5.6 Tax Arbitrage��

5.7 Organizational-Form Arbitrage��Immediate Tax Rebates When Taxable Income Is Negative

No Tax Rebates on Negative Taxable

Income��

Restrictions on Organizational-Form

Arbitrage��

Full Taxation with Deferral and Organizational-Form

Arbitrage��

The Effects of Frictions on Organizational-Form

Arbitrage��

Bankruptcy Rules and Organizational-Form

Arbitrage��

Buying and Selling Implicitly Taxed Assets to Effect Organizational-Form

Arbitrage

5.8 Clientele-Based Arbitrage��Clientele-Based Arbitrage with Investments in Tax-Favored Assets Other Than

Tax-Exempt Bonds

Market Equilibrium with Tax-Exempt

Entities��


Table of Contents

Appendix 5.1 Adjusting for Risk Using the Capital Asset PricingModel��


Exercises��



Chapter 6 Nontax Costs of TaxPlanning��

6.1 Symmetric Uncertainty, Progressive Tax Rates, and Risk-Taking R&D and O&G Activities��

Progressive Tax Rates and Hedging��

6.2 Tax Planning in the Presence of Risk-Sharing and Hidden-ActionConsiderations

Contracting in Capital Markets��

Contracting in Labor Markets��

Conflicts between Risk-Sharing and Tax

Minimization��

Conflicts between Incentive Contracting and Tax Minimization

6.3 Tax Planning in the Presence of Hidden-InformationConsiderations��

6.4 Tax Planning and OrganizationalDesign��

6.5 Accounting for Income Tax Basics and the Importance of Financial AccountingOutcomes in Tax Plans

Accounting for Corporate Income TaxesRules and Disclosure Example

Examples of Temporary Differences��

Examples of Permanent Differences��

Interpreting Income Tax Expense

Disclusures��

Example Illustrating Corporate Income Tax

Disclosures��

FIN 48 Accounting for Uncertain Tax

Benefits��

Examples of Actual Corporate

Disclosure��

Other Details about Unrecognized Tax

Benefits��

Evidence about the Importance of Financial Accounting

Income��

Book-Tax Trade-off: Income Shifting across

Time��

Table of Contents

Book-Tax Trade-off: LIFO/FIFO

Studies��

Regulatory Costs��

Asset Divestitures��

Dollar Estimates of Firms Willingness to Forgo Tax Savings

Survey Evidence and Anecdotes of Lobbying

Activity��



Exercises��



Chapter 7 The Importance of Marginal Tax Rates and Dynamic Tax-PlanningConsiderations

7.1 Marginal Tax Rate: DefinitionalIssues��

Scenario 1: TIt < 0, NOLt 1 = 0

Scenario 2: TIt < 0, NOLt 1 > 0

Scenario 3: TIt > 0, NOLt 1 = 0

Scenario 4: TIt > 0, NOLt 1 > 0

Evidence on NOLs for U.S.

Corporations��

Estimating Corporate Marginal Tax

Rates��

Additional Details on Local-Level Tax Rates and Individual-Level Marginal Rates

Average and Effective Tax Rates��

Problems with Average (and Effective) Tax

Rates��

7.2 Tax Planning for Low-Marginal-Tax-RateFirms��

7.3 Adaptability of the Tax Plan��Transaction Costs and Tax Clienteles��

Adaptability in Investment and Financing

Decisions��

7.4 Reversibility of Tax Plans��

7.5 Ability to Insure against Adverse Changes in TaxStatus��

7.6 Tax Planning When a Taxpayers Marginal Tax Rate Is Strategy-Dependent


Appendix 7.1��


Table of Contents

Exercises��



Chapter 8 Compensation Planning��8.1 Salary versus DeferredCompensation��

Employer and Employee Tax Rates Both Expected to

Fall��

2012 Tax Planning with Deferred Compensation

Plans��

Summary of Deferred Compensation

Plans��

8.2 Salary versus Fringe Benefits��Analysis for Taxable Employer��

Analysis for Tax-Exempt Employer��

Employer-Provided Meals��

8.3 Cash Bonus Plans��

8.4 Stock-Based CompensationComponents��

Restricted Stock��

Employee Tax Rates Expected to Rise��

Long-Term Performance Awards��

Employee Stock Options and Stock Appreciation

Rights��

Tax Issues Relating to Incentive Stock Options and Nonqualified Stock Options

NQOs versus ISOs��

Evidence on the Role of Taxes in the Choice of

ISOs��

Disqualifying Dispositions of ISOs��

The Role of Taxes in the NQO Exercise

Decision��

Financial Accounting and Tax Comparison of Restricted Stock, Performance Share

Awards, Stock Appreciation Rights, and Stock Options

Other Differences between Restricted Stock and SARS, PSAs, and ESOs

Compensation in Venture-Capital-Backed

Start-Ups��

Other Influences of Taxes on Compensation

Structure��

Concluding Remarks��


Appendix 8.1 Accounting for the Tax Benefits of Employee StockOptions��

Table of Contents

Appendix 8.2 SFAS 123 Accounting (up to 2005) for the Tax Benefits of StockOptions

Appendix 8.3 Backdating Stock OptionGrants��

Appendix 8.4 Incentive Stock Options and Alternative Minimum TaxComplications��


Exercises��



Chapter 9 Pension and RetirementPlanning��

9.1 Types of Pension Plans��

9.2 A Comparison of Salary and PensionCompensation��

Rates of Return on Investments In and Out of Pension

Accounts��

Antidiscrimination Rules��

9.3 Deferred Compensation versusPension��

9.4 The Stocks-versus-Bonds Puzzle��

9.5 Does It Pay to Maintain an Overfunded PensionPlan?��

Advantages and Disadvantages��

Empirical Evidence on Determinants of Defined Benefit Plan Pension Funding

9.6 Funding Post-Employment Health CareBenefits��

The Sweetened Pension Benefit

Approach��

The Pay-as-You-Go Approach��

Other Factors Relevant to the Funding

Decision��

9.7 Employee Stock-OwnershipPrograms��


Appendix 9.1 Excise TaxComplications��


Exercises��


Table of Contents


Chapter 10 Multinational Tax Planning: Introduction and InvestmentDecisions��

10.1 Overview of MultinationalTaxation��

Avoiding Worldwide Taxation��

Operating as a Branch, Partnership, or a Foreign

Subsidiary��

Foreign Tax Credits��

Subpart F Income and Controlled Foreign Corporations (CFCs)

Inversion Transactions��

10.2 How Taxes Affect the Location and Structure ofInvestments��

Large Implicit Taxes and Foreign Investment

Incentives��

10.3 The Decision to Repatriate orReinvest��

Subpart F Income and Controlled Foreign

Corporations��

A Tax Holiday for Repatriations��

Investment and Repatriation Policy When the Foreign Tax Rate Exceeds the

Domestic Tax Rate



Exercises��



Chapter 11 Multinational Tax Planning: Foreign Tax Credit Limitations and IncomeShifting��

11.1 Foreign Tax Credit Limitations andIncentives��

Example of Excess FTC Limitation��

Example of Excess FTC Credit��

Example of FTC with Multiple

Subsidiaries��

Country-by-Country FTC Limitations��

Separate Basket Limitations��

FTC Limitations and the Capital Structure of Foreign

Subsidiaries��

11.2 Shifting Income AcrossJurisdictions��

Table of Contents

Transfer Pricing��

Example of Shifting Income via Transfer

Pricing��

Rules to Mitigate Income Shifting via Transfer

Pricing��

Source-of-Income Rules��

11.3 Attempts to Encourage Exports and/or DomesticProduction��

11.4 U.S. Tax Treatment of ForeignInvestors��



Exercises��



Chapter 12 Corporations: Formation, Operation, Capital Structure, andLiquidation��

12.1 Corporate Formation��

12.2 Taxation of CorporateOperations��

Book-Tax Differences: Taxable Income versus GAAP

Income��

Net Operating Losses��

Gains and Losses and Tax Basis��

Capital Gains and Losses��

Section 1231 Assets��

Dividends Received Deduction��

Consolidated Tax Returns��

12.3 Possible Tax Benefits of Leverage in Firms’ CapitalStructures��

Theory of the Tax Benefits of

Leverage��

Empirical Work on the Tax Benefits of

Leverage��

12.4 Debt-Equity Hybrids��Traditional Preferred Stock��

Trust Preferred Stock��

Zero-Coupon Bonds��

12.5 Taxation of Distributions and ShareRepurchases��

The Concept of Earnings and Profits��

Table of Contents

Special Kinds of Distributions��

Taxation of Share Repurchases��

12.6 Tax Planning Using the Tax Rules for Distributions and Share Repurchases

12.7 Taxation of Liquidations��Parent-Subsidiary Liquidations��



Exercises��


Chapter 13 Introduction to Mergers, Acquisitions, andDivestitures��

13.1 Overview of Issues��Reasons for Mergers, Acquisitions, and

Divestitures��

Types of Mergers, Acquisitions, and

Divestitures��

13.2 Major Tax Issues Associated with Mergers, Acquisitions, andDivestitures��

Shareholder Tax Liabilities��

Effect on Tax Attributes��

Target Corporate-Level Tax Effect of The Merger, Acquisition, or Divestiture

Change in the Tax Basis of the Target or Divested Subsidiary Assets

Effect of Leverage on Mergers and

Acquisitions��

13.3 Nontax Issues in Mergers, Acquisitions, andDivestitures��

13.4 Five Basic Methods to Acquire a Freestanding CCorporation��

13.5 Four Methods to Divest a Subsidiary or Line ofBusiness��

13.6 Tax Deductibility of Goodwill and Other Intangible Assets Under Section197




Chapter 14 Taxable Acquisitions of Freestanding CCorporations��

14.1 Tax Consequences of Alternative Forms of CorporateAcquisitions��

Table of Contents

Case 1: Taxable Asset Acquisition Without a Complete Liquidation of the Target

Case 2: Sale of the Target Firm’s Assets Followed by a

Liquidation��

Case 3: Purchase of the Targets Stock Followed by a Section 338 Election

Case 4: Purchase of the Targets Stock Without a Section 338 Election

14.2 Comparison of Taxable AcquisitionStructures��

Analysis of Acquiring Firm Indifference

Price��

14.3 Practical Issues Associated with Structuring and Pricing anAcquisition��

Estimating the Net Tax Basis of a Target’s

Assets��





Chapter 15 Taxable Acquisitions of S Corporations 15.1 Tax Consequences of Taxable S Corporation Acquisition Structures

Case 1: Taxable Asset Acquisition��

Case 2: Taxable Stock Acquisition with a Section 338(h)(10) Election

Case 3: Taxable Stock Acquisition without a Section 338(h)(10) Election

Which Structure Is Optimal in the Sale of an S

Corporation?��

Advanced Analysis: S Corporation

Acquisition��

15.2 Comparison of the Sale of Similar S and CCorporations��

Tax Consequences for T1 and T2 Shareholders in a Taxable Stock Sale

Valuation Consequences and Issues��





Chapter 16 Tax-Free Acquisitions of Freestanding CCorporations��

16.1 Basic Types of Tax-FreeReorganizations��

General Requirements for Tax-Free Treatment under Section

368��

16.2 Section 368 “A” Reorganization: Statutory

Table of Contents

Merger��Requirements to Qualify for Tax-Free Treatment under Section 368(a)(1)(A)

Tax Consequences of a Section 368

“A”��

Nontax Issues Associated with the Section 368 “A”

Structure��

Triangular Mergers��

16.3 Section 368 “B” Reorganization: Stock-for-StockAcquisition��

Requirements to Qualify for Tax-Free Treatment under Section 368(a)(1)(B)


“B”��

Nontax Issues Associated with the Section 368 “B”

Structure��

16.4 Section 368 “C” Reorganization: Stock-for-AssetsAcquisition��

Requirements to Qualify for Tax-Free Treatment Under Section 368(a)(1)(C)


“C”��

16.5 Tax-Free Reorganizations Under Section351��

Requirements for Tax-Free Treatment under Section

351��


Merger��

Comparison of Tax-Free Acquisition

Structures��

16.6 Limitations on Target Firm TaxAttributes��

How Much Are the Target Firm’s NOLs

worth?��

General Limitations on a Firm’s NOLs and NOL Poison

Pills��

16.7 Quantifying Pricing Differences Between Taxable and Tax-Free Acquisitionsof Freestanding C Corporations

Additional Complexities��

16.8 Comparison of Taxable and Tax-Free Acquisitions of Freestanding CCorporations

Advanced Techniques to Provide Diversification and Tax-Free Treatment




Table of Contents


Chapter 17 Tax Planning forDivestitures��

17.1 Subsidiary Sales��Tax-Free Subsidiary Sales��

Taxable Subsidiary Sales��

Comparison of Taxable Acquisition

Structures��

Additional Complexities: Subsidiary

Sale��

Difference between Subsidiary Sales and Sales of Freestanding C Corporations

Valuation Effects��

17.2 Tax-Free Divestiture Methods��Equity Carve-Outs��

Tax-Free Spin-Offs��

Factors That Influence Divestiture Method

Choice��





Chapter 18 Estate and Gift TaxPlanning��

18.1 Fundamentals of Estate and GiftTaxation��

Specifics of the Gift Tax��

Specifics of the Estate Tax��

Income Tax Consequences of Gifts and

Bequests��

Generation-Skipping Transfer Tax��

18.2 Estate- and Gift-PlanningStrategies��

Making Full Use of the Annual Gift Tax

Exclusion��

Paying for the Kids and Grandkids Educational and Medical Expenses

Gifting in Excess of the Annual

Exclusion��

Keeping Life Insurance Out of the Gross

Estate��

Using Each Spouses Lifetime Exclusion: Credit-Shelter or Bypass Trusts

Using the Marriage Deduction to Defer Estate Taxation:

Table of Contents

QTIPs�� Family Limited Partnerships��

Transfers of Knowledge, Information, and

Services��

Charitable Remainder Trusts and Grantor Retained

Trusts��

18.3 Monetizing Appreciated Assets without Triggering Taxation: A Case Study Taxation of Short Sales��

The Strategy��

Congress Takes Action��

Avoiding the Constructive Sale Rules��

18.4 The Tax Subsidy to CharitableGiving��

18.5 A Model of the Trade-offs Between Gifting now Versus byBequest��

The Trade-offs between Gifting and Losing the Step-Up in Basis on Bequests



Exercises��



Glossary��

Index��A��

B��

C��

D��

E��

F��

G��

H��

I��

J��

K��

L��

M��

N��

O��

P��

Table of Contents

Q��

R��

S��

T��

U��

V��

W��

X��

Y��

Z��

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