Question

Isabel, a calendar-year taxpayer, uses the cash method of accounting for her sole proprietorship. In late December she received a $75,000 bill from her accountant for consulting services related to her small business. Isabel can pay the $75,000 bill anytime before January 30 of next year without penalty. Assume her marginal tax rate is 37 percent this year and next year, and that she can earn an after-tax rate of return of 10 percent on her investments.

a. What is the after-tax cost if Isabel pays the $75,000 bill in December?

    

  

b. What is the after-tax cost if Isabel pays the $75,000 bill in January? Use Exhibit 3.1. (Round your answer to the nearest whole dollar amount.)

     

c. Based on requirements a and b, should Isabel pay the $75,000 bill in December or January?

    

• December

• January

Answer 1

Consulting bill payment of $ 75,000 will be treated as a tax-deductible expense
If the bill is paid in December, this will be deducted from taxable income resulting in
less taxable income and less taxes this year.
if the bill is paid in January, the deduction will be available in next year. So the taxes paid in the current year
will be higher and will have to pay less taxes next year.
Tax benefit of this fee=	75000*37%
Tax benefit of this fee=	$ 27,750.00
This tax benefit will remain the same in both scenarios
Solution A
So after-tax cost, if paid in December	75000*63%
So after-tax cost, if paid in December	$ 47,250.00
Solution B
Taxes are paid upfront for not taking the deduction in the first year so additional taxes paid in the first year	$ 27,750.00
Interest lost on this taxes paid upfront $ 27,750*10%	$   2,775.00
Interest benefit of delaying payment- 1 month from December to January	75000*10%*1/12
Interest benefit of delaying payment	$      625.00
So after-tax cost, if paid in January	75000*63%
So after-tax cost, if paid in January	$ 47,250.00
Interest lost	$   2,775.00
Interest earned on delaying payment	$     (625.00)
After tax cost	$ 49,400.00
Solution C
After-tax cost of payment in December	$ 47,250.00
After-tax cost of payment in January	$ 49,400.00
As we can see the after-tax benefit is higher if paid in December so should be paid in December