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If we reduce expected tax payments, we should do it?

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True or False: "This transaction will reduce expected tax payments: therefore, we should do it!" Briefly explain your answer.

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Solution Summary

Your tutorial is 587 words with three scholarly references. The discussion agrees with the topic and gives numeric examples. Three exceptions are discussed (changing timing, tax deferred exchanges, and transfer pricing).

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This is generally false with a few noted exceptions.

General rule. Reducing tax payments is never a reason by itself. The reason is that reducing tax payments can only occur two ways: increasing deductions or reducing taxable receipts. In order to reduce receipts, you have to have less of them and so you are avoiding taxes by avoiding income transactions. Let's say that you didn't make a sale of $2,000. Yes, your taxes are down but so are you sales! So, while your expected tax payments are down, you are not better off. See the illustration below:

........................No Tax Avoid Avoid Receipts
Taxable receipts $ 100,000 $ 98,000
Tax deductions $ 75,000 $ 75,000
Taxable income $ 25,000 $ 23,000
Taxes due ....... $ 7,500 $ 6,900
tax rate assumed: 30%

transaction impact $ (2,000)
tax impact $ 600
net impact $ (1,400)

Let's work on the increasing deductions angle. You have to pay for something to get a deduction. So, you can reduce taxes by paying for something but this also does not ...

Solution provided by:
Carol Sargent, PhD
Education
  • BSc, University of Virginia
  • MSc, University of Virginia
  • PhD, Georgia State University
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