Instructor’s Solutions Manual Taxes and Business Strategy A Planning Approach Fifth Edition

Chapter 1
Introduction to Tax Strategy
Discussion Questions
1. When facing a business decision in which taxes play a role, a planner employing efficient tax
planning considers all of the costs, tax and nontax, that will be incurred by all of the parties to the
transaction. In addition to the explicit tax payments that will result from the transaction, the planner
considers implicit taxes that parties will pay in the form of lower before-tax rates of return on tax-favored
investments as well as any other non-tax costs associated with the transaction such as the costs of
restructuring an organization to obtain favorable tax treatment. A planner whose criterion is tax
minimization, on the other hand, ignores many of these costs. A tax minimizer considers only explicit tax
costs. It is easy to see that such a criterion may not result in desirable business strategies when one
considers that zero taxes are paid on unprofitable investments.
2. Social planners should encourage taxpayers to engage in costly tax planning when no alternative
means of attaining the same social goals is less costly. For example, consider the social goal of providing
low-income housing. A system of tax subsidies to providers of this housing may require some taxpayers
to incur costs in considering the explicit taxes, implicit taxes, and nontax costs that would affect them and
other parties if they were to build low-income housing. If the next-best alternative means of providing
low-income housing is for the government to build it directly, the social costs associated with providing
this housing may be higher.
3. a. Implicit taxes arise because before-tax rates of return on tax-favored assets are less than those
available on tax-disfavored assets. Examples of tax-favored investments include tax-exempt bonds,
business equipment eligible for accelerated depreciation, energy-related investments, research and
development, agricultural production, foreign export activities, retirement saving, and entrepreneurial
risk-taking activities.
b. High tax-bracket taxpayers should undertake these investments rather than paying high
explicit taxes on investments with higher before tax rates of return but lower after-tax rates of return.
Many of these investors do indeed undertake these investments, but nontax considerations also impede
their propensity to do so. Later chapters elaborate on how taxpayers determine whether they are in this
clientele.
c. The issuer or seller of the tax-favored asset receives the implicit taxes. Issuers benefit because
they receive higher prices for the securities they are issuing or alternatively they raise funds at a lower
before-tax rate of return. Sellers of tax-favored assets receive the implicit taxes via higher selling prices
of the asset.
4. a. This statement is correct since municipal bonds are tax-favored.
b. This statement is not correct. For example, suppose (1) your tax rate is 30% and you can invest
in municipal bonds that yield 10% or equally risky taxable bonds that yield 16%. You should invest in the