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Reese, a calendar-year taxpayer, uses the cash method of accounting for her sole proprietorship. In late...

Reese, a calendar-year taxpayer, uses the cash method of accounting for her sole proprietorship. In late December, she received a $15,000 bill from her accountant for consulting services related to her small business. Reese can pay the $15,000 bill anytime before January 30 of next year without penalty. Assume Reese’s marginal tax rate is 32 percent this year and will be 37 percent next year, and that she can earn an after-tax rate of return of 9 percent on her investments.

a. What is the after-tax cost if she pays the $15,000 bill in December?

    

b. What is the after-tax cost if she pays the $15,000 bill in January? Use Exhibit 3.1. (Round your answer to the nearest whole dollar amount.)

    

c. Based on requirements a and b, should Reese pay the $15,000 bill in December or January?

    

December

January

   course: federal taxe procedure

Solutions

Expert Solution

(a) Computation of the after-tax cost if she pays the $15,000 bill in December.We have,

Present value of tax saving = Bill payment(Tax deduction) x Tax rate

Present value of tax saving = 15,000 x 32% = $ 4,800

After-tax cost = Pre-tax cost - Present value of tax saving

After tax cost = 15,000 - 4,800 = $ 10,200

After tax cost $ 10,200

(b) Computation of the after-tax cost if she pays the $15,000 bill in January.We have,

Present value of tax saving = Bill payment(Tax deduction) x Tax rate

Value of tax saving = 15,000 x 37% = $ 5,550

Present value of tax saving = Value of tax saving x PVIF(9%,1year)

Present value of tax saving = 5,550 x 0.917 = $ 5,089

After-tax cost = Pre-tax cost - Present value of tax saving

After tax cost = 15,000 - 5,089 = $ 9,911

After tax cost $ 9,911

(c) Reese should pay bill in January because in January after tax cost $ 9,911 which is lower than December after tax cost which is $ 10,200.

jeff jeffy answered 2 years ago
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