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TAX 4001 Midterm Exam Questions With
Correct Answers
1. Jason engaged in a transaction that generated $50,000 of cash. Assuming Jason's marginal tax rate is
40% and only $40,000 of the income is taxable, what is Jason's after tax cashflow?
$20,000
$40,000
$34,000
$24,000 - answer✔$34,000
(40,000*.4) = 16,000
50,000 - 16,000 = 34,000
2. Bob has $200,000 in an investment paying 8% annual interest. His marginal tax rate is 40%. Which of
the following statements is false?
- Bob's annual before-tax cash flow from this investment is $16,000.
- None of these choices are false.
- If the interest is tax-exempt, Bob's annual after-tax cash flow is $16,000.
- If the interest is taxable, Bob's annual after-tax cash flow is $6,400. - answer✔- If the interest is
taxable, Bob's annual after-tax cash flow is $6,400.
3. Frank recently traveled to another state to buy furniture and paid that state's 4% sales tax. Frank
resides in a state with a 6% sales and use tax. Which of the following statements is true?
- None of these choices are true.
- Frank does not owe a use tax to his home state.
- Frank's use tax liability to his home state equals 6% of the purchase price of the furniture.
- Frank's use tax liability to his home state equals 2% of the purchase price of the furniture. - answer✔-
Frank's use tax liability to his home state equals 2% of the purchase price of the furniture.
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4. Which of the following statements is false?
- A theoretical justification for a proportionate rate is its superior potential for wealth redistribution.
- Under a proportionate rate structure, the taxpayer with the least income pays the same percentage of
income to the government as the taxpayer with the most income.
- None of the choices are false.
- Under a proportionate rate structure, the marginal rate equals the average rate. - answer✔- A
theoretical justification for a proportionate rate is its superior potential for wealth redistribution.
Proportionate tax: Same tax rate regardless of income
5. A taxpayer spent $2.3 million on a new advertising campaign this year. Which of the following
statements is true?
- The $2.3 million cost results in an unfavorable book/tax difference.
- The company is allowed to deduct the $2.3 million cost on this year's tax return only if it expenses the
advertising costs for financial statement purposes.
- The company is allowed to deduct the $2.3 million cost.
- The company must capitalize the $2.3 million cost. - answer✔- The company is allowed to deduct the
$2.3 million cost.
6. ABC has the opportunity to engage in a transaction that will generate $250,000 taxable cash flow.
Alternatively, CBA could engage in the transaction. However, CBA would incur an extra $60,000
deductible cash expense with respect to the transaction. Assume ABC Incorporated and CBA
Incorporated are owned by the same family and that ABC's marginal tax rate is 30% while CBA's
marginal tax rate is 21%.Which of the following statements is true?
- Because ABC and CBA are owned by the same family, the family is indifferent as to which corporation
engages in the transaction.
- CBA should engage in the transaction because it has the lower marginal tax rate.
- ABC should engage in the transaction to avoid the extra expense.
- ABC should engage in the transaction to generate $24,900 more after-tax cash flow. - answer✔- ABC
should engage in the transaction to generate $24,900 more after-tax cash flow.
7. This year, DDT incurred $25 million of business interest expense, earned no business interest income,
and has adjusted taxable income of $42 million. Assuming DDT Corp must apply the limitation on net
interest expense, what is DDT's current deduction for business interest?
- $7.5 million
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- $0
- $12.6 million
- $25 million - answer✔- $12.6 million
12.6 = 42 * .3
8. Which of the following statements is false?
- The entity variable becomes more important when Congress increases the progressivity of the income
tax.
- Tax planning strategies based on the entity variable must involve some type of income taxed at a
preferential rate.
- Tax planning strategies based on the entity variable must involve at least two different taxpayers.
- If Congress replaced the current progressive income tax rates with a proportionate rate applying to all
taxpayers, the entity variable would no longer be a factor in tax planning. - answer✔- Tax planning
strategies based on the entity variable must involve some type of income taxed at a preferential rate.
9. Which of the following tax policies would increase vertical equity?
- Repealing the federal estate and gift taxes
- Replacing the income tax with a national sales tax
- Replacing the progressive income tax rate structure with a flat rate
- Increasing the highest marginal income tax rate by 10% - answer✔- Increasing the highest marginal
income tax rate by 10%
10. In 2022, Driving Inc purchased assets and elected to expense the entire cost using Section 179.
However, Driving could not deduct $100,000 of the Section 179 expense because of the taxable income
limitation. In 2022, Driving purchased tangible personalty costing $1,090,000. Driving's taxable income
before any Section 179 deduction was $1,912,400. Compute Driving's 2022 Section 179 deduction.
- $100,000
- $1,190,000
- $0
- $1,080,000 - answer✔- $1,080,000
11. Which of the following statements is true?
- The value of tax deferral increases as the taxpayer's discount rate for computing NPV decreases.
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- The greater the length of time that the payment of a tax is deferred, the less the tax costs in NPV
terms.
- The value of tax deferral increases as the taxpayer's discount rate for computing NPV decreases and
the greater the length of time that the payment of a tax is deferred, the less the tax costs in NPV terms.
- Tax deferral is not an effective planning strategy if the taxpayer's marginal tax rate is stable over time. -
answer✔- The greater the length of time that the payment of a tax is deferred, the less the tax costs in
NPV terms.
12. Fey is a Brazilian citizen who permanently resides in Houston, Texas. Which of the following
statements is true?
- The U.S. government has jurisdiction to tax Fey.
- The U.S. government has jurisdiction to tax Fey only on income that she earns from a source within the
United States.
- Fey can elect whether to pay tax to the United States or to Brazil.
- Under no circumstances would the U.S. government have jurisdiction to tax Fey. - answer✔- The U.S.
government has jurisdiction to tax Fey.
13. Four years ago, Toby Incorporated paid a $5 million to purchase a business. Toby allocated $600,000
of the price to goodwill. Which of the following statements is true?
- None of these choices are true.
- This year, Toby has a $40,000 favorable temporary difference because of the accounting treatment of
goodwill.
- The accounting treatment of the goodwill does not result in any book/tax difference in the current
year.
- This year, Toby has a $40,000 unfavorable temporary difference because of the accounting treatment
of goodwill. - answer✔- This year, Toby has a $40,000 favorable temporary difference because of the
accounting treatment of goodwill.
40,000 = 600,000 * 12/180
14. Company Z, which has its home office in Atlanta, Georgia, conducts business in the United States,
Canada, and Mexico. Which of the following statements is true?
- Because Company Z must pay income tax to Georgia, it is not required to pay tax to any other state.
- Because Company Z must pay income tax to the United States, it is not required to pay tax to Canada
or Mexico.
