Question

In the current year, Jill, age 35, received a job offer with two alternative compensation packages to choose from. The first package offers her $91,400 annual salary with no qualified fringe benefits and requires her to pay $4,200 a year for parking and to purchase life insurance at a cost of $1,700. The second package offers $81,400 annual salary, employer-provided health insurance, annual free parking (worth $385 per month), $200,000 of life insurance (purchasing on her own would have been $1,700 annually), and free flight benefits (she estimates that it will save her $5,700 per year). If Jill chooses the first package, she will purchase the health and life insurance benefits herself at a cost of $5,700 and $ 1,700 respectively, annually after taxes and spend another $5,700 in flights while traveling. Assume her marginal tax rate is 32 percent. (Use Exhibit 12-8.)

Required:

a1. Which compensation package should she choose?

Answer: Package 2 offers $81,400 annual salary plus qualified fringe benefits like health and life insurance benefits, parking, flight tickets.radio button checked

a2. How much would she benefit in after-tax dollars by choosing this compensation package instead of the alternative package?

Answer: ?

b1. Assume the first package offers $100,000 salary with no qualified benefits instead of $91,400 salary and the other benefits and costs are the same. Which compensation package should she choose?

Answer: Package 2 offers $81,400 annual salary plus qualified fringe benefits like health and life insurance benefits, parking, flight tickets.radio button checked

b2. How much would she benefit in after-tax dollars by choosing this package?

Answer: ?

Answer 1

A-1)

Value of First package = $ 91,400 (No fringe benefits)

Value of Second package = $ 81,400

Add: ) Value of parking benefits at first job (Opportunity cost) = $ 4,200

Add: ) Value of flight benefits = $ 5,700

Add: ) Value of insurance premium = $ 1,700

Total value of Second package = $ 93,000

Second Package Net Benefit = (93,000 – 91,400) = $ 1,600

Therefore Jill should choose the second package, as inclusive of the fringe benefits being provided with the salary package it is more beneficial compared to the first package.

A-2)

Value of First package = $ 91,400

Less: ) Insurance premium paid = $1,700

Net Taxable Income (First package) = $ 89,700

Net Tax Payable @ 32% = (89,700 x 0.32) = $ 28,704

Net value of First package (after tax) = (91,400 – 28,704) = $ 62,696

Value of Second package = $ 81,400

Add: ) Value of parking benefits at first job (385 x 12) = $ 4,680

Add: ) Value of flight benefits = $ 5,700

Add: ) Value of insurance premium = $ 1,700

Net Taxable Income (Second package) = $ 93,480

Net Tax Payable @ 32% =   (93,480 x 0.32) = $ 29,914

Net value of Second package (after tax)   =   (93,480 – 29,914)   =   $ 63,566

Second Package Net Benefit (after tax) = (63,566 – 62,696) = $ 870

Although due to lesser tax deductions the Net Benefit (after tax) has reduced but Jill should still choose the second package, as inclusive of the fringe benefits being provided with the salary package it is more beneficial compared to the first package.

A-3)

Value of First package = $ 100,000 (No fringe benefits)

Value of Second package = $ 81,400

Add: ) Value of parking benefits at first job (Opportunity cost) = $ 4,200

Add: ) Value of flight benefits = $ 5,700

Add: ) Value of insurance premium = $ 1,700

Total value of Second package = $ 93,000

First Package Net Benefit = (100,000 - 93,000) = $ 7,000

Therefore Jill should choose the first package, as the amount paid is higher than the salary inclusive of the fringe benefits being provided in the second package, thus it is more beneficial compared to the second package.

A-4)

Value of First package = $ 100,000

Less: ) Insurance premium paid = $1,700

Net Taxable Income (First package) = $ 98,300

Net Tax Payable @ 32% = (98,300 x 0.32) = $ 31,456

Net value of First package (after tax) = (100,000 – 31,456) = $ 68,544

Value of Second package = $ 81,400

Add: ) Value of parking benefits at first job (385 x 12) = $ 4,680

Add: ) Value of flight benefits = $ 5,700

Add: ) Value of insurance premium = $ 1,700

Net Taxable Income (Second package) = $ 93,480

Net Tax Payable @ 32% = (93,480 x 0.32) = $ 29,914

Net value of Second package (after tax)   =   (93,480 – 29,914)   =   $ 63,566

First Package Net Benefit (after tax) = (68,544 - 63,566) = $ 4,978

Due the higher salary and the deduction for insurance expenses the Net Benefit (after tax) for the first package is higher compared to the second package, thus Jill should choose the first package.