Question

Reese, a calendar-year taxpayer, uses the cash method of accounting for her sole proprietorship. In late December, she received a $35,000 bill from her accountant for consulting services related to her small business. Reese can pay the $35,000 bill anytime before January 30 of next year without penalty. Assume Reese’s marginal tax rate is 30 percent this year and will be 40 percent 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 she pays the $35,000 bill in December?

b.What is the after-tax cost if she pays the $35,000 bill in January?

c. Based on requirement a and b, should Reese pay the $35,000 bill in December or January?

Answer 1

(A) IF PAYS IN DECEMBER

If reese pays in december current year he has to pay amonut in december 35000 and she can reduce tax at the rate 30 % on it by claiming deduction for this expenses. so she can save from her tax liability as

$35000 x 30% = $10500

(B) IF PAYS IS JANUARY

If leese pays this expenses in January next year she will retain this amount till january 30 as till she will not be liable to any penalty so she can earn on investment of 350000 at the rate 10 percent after tax, so it will be

35000 x 10% x 1/12 = $291.67 or $292 after tax.

and she will also pay tax one year later from option a so she will asume to bear tax amount of $10500 for one year (tax of option a) so this will cost in

10500 x 10% = $1050 after tax

and she will pay tax after one year than option a at the rate 40 percent so she will save in tax next year as

35000 x 40% = $14000

so total cost in option B will be = 14000 + 292 - 1050 = $13242

C WHICH OPTION IS BETTER

In option a leese is saving $10500 in tax but in option b leese is saving $13242 in tax, so leese should pay the $35000 bill in January.