Question

Assume that a taxpayer can choose when he is to receive $10,000 of fully taxable income. If the taxpayer receives the income at the end of Year 1, he will receive exactly $10,000. If he delays receipt of the income until the end of Year 2, the amount will grow to $11,000. If the taxpayer takes the money at the end of Year 1, he can invest the proceeds and earn a pretax return of 10 percent over the next year.

1. If the taxpayer faces a marginal tax rate of 31 percent in both Year 1 and Year 2, when should he elect to receive the income?

2. At what pretax rate of return will the taxpayer be indifferent to taking the money in Year 1 and Year 2?

3. If the taxpayer’s marginal tax rate increases to 35 percent in Year 2, when should he elect to receive the income?

4. What would the tax rate need to be in Year 2 to make the taxpayer indifferent to the alternatives?

Answer 1

ANSWER

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