Instructor’s Solutions Manual
Taxes and Business Strategy
A Planning Approach
Fifth Edition
Myron Scholes
Mark Wolfson
Merle Erickson
Michelle Hanlon
Ed Maydew
Terry Shevlin
0
, CONTENTS
Chapter 1 Introduction to Tax Strategy 1
Chapter 2 Tax Law Fundamentals 8
Chapter 3 Returns on Alternative Savings Vehicles 18
Chapter 4 Choosing the Optimal Organizational Form 30
Chapter 5 Implicit Taxes and Clienteles, Arbitrage, Restrictions and Frictions 48
Chapter 6 Nontax Costs of Tax Planning 67
Chapter 7 The Importance of Marginal Tax Rates and Dynamic Tax Planning Considerations 82
Chapter 8 Compensation Planning 93
Chapter 9 Pension and Retirement Program Planning 107
Chapter 10 Multinational Tax Planning: Introduction and Investment Decisions 121
Chapter 11 Multinational Tax Planning: Foreign Tax Credit Limitations and Income Shifting 127
Chapter 12 Corporations: Formation, Operation, Capital Structure and Liquidation 133
Chapter 13 Introduction to Tax Planning for Mergers, Acquisitions and Divestitures 136
Chapter 14 Taxable Acquisitions of Freestanding C Corporations8 139
Chapter 15 Taxable Acquisitions of S Corporations 144
Chapter 16 Tax-Free Acquisitions of Freestanding C Corporations 151
Chapter 17 Tax Planning for Divestitures 162
Chapter 18 Estate and Gift Tax Planning 172
1
,NOTE TO INSTRUCTORS
Much care and attention has gone into the preparation of this Solutions Manual. Despite these efforts,
some minor errors may have escaped our notice. We would appreciate your apprising us of any errors
you encounter. Please email us at .
We would also appreciate any comments or feedback on your experiences using the book and on
suggestions for revising the text.
2
, 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
1
Taxes and Business Strategy
A Planning Approach
Fifth Edition
Myron Scholes
Mark Wolfson
Merle Erickson
Michelle Hanlon
Ed Maydew
Terry Shevlin
0
, CONTENTS
Chapter 1 Introduction to Tax Strategy 1
Chapter 2 Tax Law Fundamentals 8
Chapter 3 Returns on Alternative Savings Vehicles 18
Chapter 4 Choosing the Optimal Organizational Form 30
Chapter 5 Implicit Taxes and Clienteles, Arbitrage, Restrictions and Frictions 48
Chapter 6 Nontax Costs of Tax Planning 67
Chapter 7 The Importance of Marginal Tax Rates and Dynamic Tax Planning Considerations 82
Chapter 8 Compensation Planning 93
Chapter 9 Pension and Retirement Program Planning 107
Chapter 10 Multinational Tax Planning: Introduction and Investment Decisions 121
Chapter 11 Multinational Tax Planning: Foreign Tax Credit Limitations and Income Shifting 127
Chapter 12 Corporations: Formation, Operation, Capital Structure and Liquidation 133
Chapter 13 Introduction to Tax Planning for Mergers, Acquisitions and Divestitures 136
Chapter 14 Taxable Acquisitions of Freestanding C Corporations8 139
Chapter 15 Taxable Acquisitions of S Corporations 144
Chapter 16 Tax-Free Acquisitions of Freestanding C Corporations 151
Chapter 17 Tax Planning for Divestitures 162
Chapter 18 Estate and Gift Tax Planning 172
1
,NOTE TO INSTRUCTORS
Much care and attention has gone into the preparation of this Solutions Manual. Despite these efforts,
some minor errors may have escaped our notice. We would appreciate your apprising us of any errors
you encounter. Please email us at .
We would also appreciate any comments or feedback on your experiences using the book and on
suggestions for revising the text.
2
, 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
1
