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In: Accounting

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

Manny, a calendar-year taxpayer, uses the cash method of accounting for his sole proprietorship. In late December he performed $24,000 of legal services for a client. Manny typically requires his clients to pay his bills immediately upon receipt. Assume Manny’s marginal tax rate is 37 percent this year and next year, and that he can earn an after-tax rate of return of 7 percent on his investments.

a. What is the after-tax income if Manny sends his client the bill in December?

b. What is the after-tax income if Manny sends his client the bill in January?

3. Hank, a calendar-year taxpayer, uses the cash method of accounting for his sole proprietorship. In late December, he performed $20,000 of legal services for a client. Hank typically requires his clients to pay his bills immediately upon receipt. Assume his marginal tax rate is 32 percent this year and will be 37 percent next year, and that he can earn an after-tax rate of return of 12 percent on his investments.

a. What is the after-tax income if Hank sends his client the bill in December?

b. What is the after-tax income if Hank sends his client the bill in January?

Solutions

Expert Solution

Manny

a) Taxable income = 24,000

Marginal tax rate = 37%

Tax liability = $8,880 (present value of tax)

After tax income = 24,000 - 8,880

= $15,120

b) Tax liability = $8,880 (as the tax rate is same)

If bill is sent in January:

Present value of tax will be = $8,880 * 0.9345 (discount factor , year 1 , 7% )

= $8,298

After tax income = 24,000 - 8,298

= $15,702

Hank

a) Taxable income = $20,000

Marginal tax rate = 32%

Tax liability = 20,000 * 32%

= $6,400

After tax income = 20,000 - 6,400

= $13,600

b) Taxable income = $20,000

Marginal tax rate = 37%

Tax liability = 20,000 * 37%

= $7,400

Present Value of tax = 7,400 * 0.8928 (discount factor , 1 Year , 12%)

= $6,607

After tax income = 20,000 - 6,607

= $13,393

(NOTE: In discounting factor I have taken upto 4 decimals(as nothing was mentioned) , the answer will vary a little if 2 or 3 decimals are taken, and accordingly the after tax values will also change a little)

ekkarill92 answered 3 months ago
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