Corporate Development

MBA 602
Taxes and Business
Ron Worsham
534 TNRB
[email protected]
My Philosophy of Learning
I hear and I forget;
I see and I remember;
I do and I understand.
Old Confucian Proverb
1. The owner of a municipal bond incurs tax
on its earnings. True or False?
2. If you were the president of a company,
you would want the company to always
minimize its tax bill. True or False?
3. Consider EVERY tax planning technique
(simple or sophisticated). Would you
believe that there are really only three tax
planning strategies in the universe? Yes or
Why should MBA students study tax planning?
Tax planning has come to be recognized as a
significant value adding enterprise among executives
and managers because….
Management is more focused on reducing effective tax
rates as reported in financial statements.
Globalization and disruptive technologies such as the
Internet require as well as facilitate tax planning.
Many securities and investments have significant tax
Greater Focus on Effective Tax Rates
Effective tax rates have recently been benchmarked.
CFO Magazine began publishing comparative effective
tax rates by industry in the fall of 1999 and continues
to do so.
Managers now feel more pressure to reduce effective
tax rates.
“You don’t want to be the one paying the highest
effective tax in your business” (Business Week,
April 12, 1999, p.47)
Greater Focus on Effective Tax Rates
The use of equity as a form of management compensation.
Compensation tied to stock prices.
Executives now view effective tax rate reduction as a
means of increasing share price.
Do lower ETR firms have higher P/E ratios?
Empirical research seems to suggest yes!
“A long-term sustainable reduction in a company’s
effective tax rate can have a significant impact on
market capitalization and shareholder value”,
according to Michael Burke, KPMG’s global managing
partner of total tax minimization services.
Greater Focus on Effective Tax Rates
More managers are compensated based upon after-tax
“Were pre-tax income to govern incentives, then
employees with bonuses on their minds would pay far
less attention to favorable tax implications…It’s a very
high priority. Managing taxes is a job for everyone at
Stephen Patrick
Chief Financial Officer, Colgate-Palmolive Co.
Globalization and the Internet
•As companies restructure their operations in
response to these forces, tax considerations
play an important role.
•Frictions that normally impede tax planning
are disappearing.
•“Electronic Commerce Transformation: An
Unprecedented Tax Planning Opportunity”
(Taxes, March 2001).
Investment Bankers Create Tax
Motivated Securities
• $70 Billion in contingent convertible
debt (coco’s) issued in 2001.
• ETF’s are gaining ground on traditional
mutual funds.
• ARP’s and other forms of preferred
stock designed to create tax benefits.
Benefits of Tax Planning for
• Entity Selection
• Tax considerations of starting, buying
and selling businesses
• Integrate family and business tax
Individual Benefits of Understanding Tax
• Maximize retirement savings
• Increase after-tax returns in your
investments portfolio
• Negotiate compensation considering tax
• Increased awareness of general
individual tax planning strategies
Investing and Tax Planning
• Suppose you had to choose between
tax planning knowledge and stock
investment expertise. Which would you
Investing and Tax Planning
Assume the following:
1. You have $5,000 of cash.
2. You wish to invest that money for the
long-term, say 30 years.
3. Your individual tax rate is 40%.
4. You can invest the $5,000 in a stock index
fund which mirrors the overall stock
market providing an average annual 12%
return on investment and requires no
investment expertise. (passive 30 year
What happens if you choose to learn
tax planning and implement the use of
a 401(k) plan for investment in an index
fund which requires no investment
The after-tax value of the $5,000
investment after 30 years would be
- What would happen if you choose to
become an investment expert but do not use
a 401(k) for the investment?
- You would have to pick stocks that would
generate a 20% average annual return in
order to achieve a similar after tax value of
- Beating the market (an index fund) by 8%
consistently over a 30-year period would be
highly unlikely.
If you failed to beat the market in
picking stocks and only achieved a 12%
average annual return on investment,
the after-tax value of your investment
at the end of 30 years without the use
of a 401(k) plan would be only about
$40,000 as opposed to the $149,000
with a 401(k).
Of course, tax planning and investing
expertise are not mutually exclusive.
What if you can beat the market by 8% per
year and be a good tax planner utilizing a
401(k) plan?
In this instance, the after-tax value of
your $5,000 investment would be