Strategic Business Tax Planning

JOHN E. KARAYAN, JD, PHD, is a professor at California State Polytechnic University, Pomona. He is also a Partner at the law firm of Bond Karayan. Prior to his academic career, he was director of taxes at Informatics General Corporation (now Sterling Software); assistant tax counsel at The Parsons Corporations, and supervising specialist at Coopers & Lybrand (now PricewaterhouseCoopers). He is the Editor in Chief of the Journal of Interdisciplinary Studies as well as a member of the editorial review board (former associate editor) of Mid-Atlantic Journal of Business, Research in Healthcare Financial Management, and the Business Forum Journal. CHARLES W. SWENSON, CPA, PHD, is Professor and Leventhal Research Fellow in the Marshall School of Business at the University of Southern California, where he has taught for the last nineteen years. He holds a joint appointment at the California Institute of Technology (Caltech). His practice experience includes PricewaterhouseCoopers and Deloitte & Touche. He is a member of the AICPA and the American Economics Association, and is a cofounder of the National Tax Credit Group, LLC.

About the Authors v

Acknowledgments xiii

Introduction xv

Part 1 Strategic Tax Planning 1

Chapter 1 A Framework for Understanding Taxes 3

How are Taxes Important in Decision Making? 5

Types of Taxes 8

Basic Principles of Taxation 30

Sources of Tax Laws 35

Important Principles and Concepts in Tax Law 42

SAVANT Framework 56

Chapter 2 Using the SAVANT Framework to Guide Tax Planning 61

Strategy 63

Anticipation 66

Value-Adding 72

Negotiating 83

Transforming 85

Putting It All Together: SAVANT Concepts Illustrated 87

Part 2 Forming the Enterprise 93

Chapter 3 Choosing a Legal Entity: Risk Management, Raising Capital, and Tax Management 95

Strategy 100

Anticipation and Timing Issues 106

Value-Adding 108

Negotiating 110

Transforming 112

Putting It All Together: Applying SAVANT to Entity Choice 116

Specialized Legal Forms 118

Chapter 4 Financing a New Venture 125

Internal Financing 126

External Financing: Debt versus Equity 129

Part 3 Operating the Firm 153

Chapter 5 New Products: Development, Promotion, and Advertising 155

New Products and Product Improvement 155

SAVANT and Research and Development 175

Chapter 6 Attracting and Motivating Employees and Managers: Company and Employee Tax Planning 179

Executive Compensation 180

Nonexecutive Employee Compensation 182

Perquisites 189

Pension and Profit-Sharing Plans 191

Current and Deferred Compensation 195

Limits on Deductibility on Executive Compensation 195

Stock Options 196

Management Bonus Plans 202

Financial Statement/Finance versus Tax Strategy Trade-Offs 204

Putting It All Together: Applying SAVANT to Executive Compensation 206

Chapter 7 Market Penetration: Operating in Different States 213

General Principles of State and Local Taxation 216

Planning with Income Taxes: Manipulation of Plant, Workforce, and Point-of-Sale Locations 217

Location Choice: Sourcing versus Production Platforms 228

Distribution: Planning for Sales and Use Taxes 230

Lobbying and Tax Abatements 235

Trade-Offs with Local Tax Incentives: Infrastructure, Government Costs/Subsidies, and Other Local Costs 237

Putting It All Together: SAVANT Applied to Market Penetration in Other States 237

Chapter 8 Market Penetration: Company and Employee Tax Planning for Operating in Foreign Countries 241

Some Basics on U.S. Taxation of Overseas Operations 241

Some Basics on Taxation by Countries Other than the United States 244

Tax Treaties 245

Effective Tax Management 247

Putting It All Together: Penetrating Foreign Markets from a SAVANT Perspective 263

Chapter 9 Operations Management 269

Production Design and Process Selection 269

Inventory: Methods of Accounting and Includable Amounts 273

Strategic Capacity Planning: Plant versus People 283

Putting It All Together: Operations Management from a SAVANT Perspective 289

Chapter 10 Financing Ongoing Operations and Tax Planning 293

Operating Earnings 294

Sale of Operating Assets 294

Sale of Investments 296

Short-Term Borrowing 298

Accounts Receivable 299

Decrease in Dividends 300

Stock Dividends 302

Stock Buybacks 303

Using Employee Stock Ownership Plans 305

Receipt of Dividends from Subsidiaries 306

Putting It All Together: Financing Ongoing Operations from a SAVANT Perspective 312

Chapter 11 Capital Budgeting 319

Fixed Asset Acquisition 319

Analysis from a SAVANT Perspective 324

Putting It All Together: SAVANT Concepts Applied to Capital Budgeting 332

Make or Buy Decisions 334

Capital Budgeting and Plant Capacity 338

Risk Considerations 343

Chapter 12 Financial Statement Analysis and Proactive Tax Planning 347

Segmental Analysis 347

Other Tax Aspects in Segmental Analysis 350

Strategic Analysis: Using Competitor’s Tax Note and Segmental Data 356

Part 4 Changing Original Form 367

Chapter 13 Restructuring 369

Financial Restructuring 369

Financial Restructuring in the SAVANT Framework 372

Business Restructuring 375

Legal Entity Restructuring 376

Divestitures in the SAVANT Framework 382

Selling Off Parts of the Business 383

Selling a Business to an Outside Entity 384

Chapter 14 Mergers and Acquisitions 391

Some General Tax Rules 393

Tax-Free Mergers and Acquisitions 393

Statutory Mergers and Consolidations 395

Taxable Mergers and Acquisitions 402

Tax Planning and Acquisition Costs 405

Allocating Purchase Price 406

Financial Accounting Trade-Offs 406

Maximizing Tax Benefits 407

Leveraged Buyouts 411

Sources of Merger and Acquisition Finance 412

Defensive Strategies 415

Merger and Acquisition Activity and Scrutiny by Tax Authorities 416

Putting It All Together: Merger and Acquisition from a SAVANT Perspective 417

Chapter 15 Other Topics in Changing Original Form 421

Use of Flow-Through Entities for Divestitures 421

Use of Flow-Through Entities for Acquisitions 425

Liquidations 426

Buying a Subsidiary for Its Assets 432

Fighting Off Takeover Attempts with ESOPs 437

Bankruptcies 439

Appendix A Basic Tax Research Skills 441

Steps in the Research Process 441

Sources of the Law 441

Getting Answers to Simple Questions 443

Appendix B Present Value Analysis: Lump Sums 445

Annuities 447

Uneven Cash Flows 449

Index 451