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

Hank, a calendar-year taxpayer, uses the cash method of accounting for his sole proprietorship. In late December, he performed $21,000 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 4 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? Use Exhibit 3.1. (Round your answer to the nearest whole dollar amount.) c. Based on requirement a and b, should Hank send his client the bill in December or January? 4% 5% 6% 7% 8% 9% 10% 11% 12% Year 1 .962 .952 .943 .935 .926 .917 .909 .901 .893 Year 2 .925 .907 .890 .873 .857 .842 .826 .812 .797 Year 3 .889 .864 .840 .816 .794 .772 .751 .731 .712 Year 4 .855 .823 .792 .763 .735 .708 .683 .659 .636 Year 5 .822 .784 .747 .713 .681 .650 .621 .593 .567 Year 6 .790 .746 .705 .666 .630 .596 .564 .535 .507 Year 7 .760 .711 .665 . .623 .583 .547 .513 .482 .452 Year 8 .731 .677 .627 .582 .540 .502 .467 .434 .404 Year 9 .703 .645 .592 .544 .500 .460 .424 .391 .361 Year 10 .676 .614 .558 .508 .463 .422 .386 .352 .322 Year 11 .650 .585 .527 .475 .429 .388 .350 .317 .287 Year 12 .625 .557 .497 .444 .397 .356 .319 .286 .257 Year 13 .601 .530 .469 .415 .368 .326 .290 .258 .229 Year 14 .577 .505 .442 .388 .340 .299 .263 .232 .205 Year 15 .555 .481 .417 .362 .315 .275 .239 .209 .183

Solutions

Expert Solution

The concept is based on whether to send the bill to the client on January or December i.e. loosely on present value. When, the bill is sent on January, the time value will not come into play. On the other hand, when the bill is sent on December, i.e. 1 year from now, the tax amount would be discounted using rate of 4% given and present value of tax shall be deducted from taxable income. Whichever has lesser after tax income, Hank should prefer sending the bill in that time.

Taxable Income	$ 21000
Marginal Tax Rate	32%
Tax amount	$ 6720
After tax income	$ 14280

A. Taxable Income	$ 21,000
Marginal Tax Rate	37%
Tax amount	$ 7,770
B. Present value of tax (7770*0.962) using (4%,1yr)	$ 7,475
C. After tax income (A-B)	$ 13,525

c. After-tax income is less in December. Hence, Hank should send his client the bill in December.

kindly upvote

ekkarill92 answered 1 year ago

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