Question

Assignment Score: S00% nt: Chapter 3 HW Save Submit Assignment for Grading e Question 3 of 4 ch03 Financial Planning Exercise 4 Check My Work eBook Chapter 3 Financial Planning Exercise 4 Effect of tax credit vs. tax exemption By defining after-tax income, demonstrate the differences resulting from a $500 tax credit versus a $500 tax deduction for a single taxpayer in the 25% tax bracket with $40,000 of pre-tax income. Round your answers to two decimal places. (Use Exhibit 3.3. Deduction $ Credit Check My Work Cho3 Financial Planning Exercise 3 Question 3 of Type here to search 0

Answer 1

For a single tax payer, an after tax income is the net disposable income available to the tax payer after taking care of (deducting) all the federal, state and income tax liabilities.

A tax credit:

1. Reduces the amount of taxes to be paid in 1:1 proportion. That means for every dollar of tax credit you have, your tax bill goes down by one dollar.
2. Does not impact your taxable income. It straightway sets off the tax liability.

A tax deduction:

1. Reduces your taxable income
2. Which in turn reduces your tax liability
3. A tax deduction leads to a reduction in tax bill but it's not 1:1.
4. The reduction in tax bill is dependent upon marginal tax rate.

In case of $ 500 tax deduction:

1. The marginal income goes down by $ 500
2. And that leads to reduction in tax bill by an amount = $ 500 x marginal tax rate = $ 500 x 25% = $ 125.
3. Please put 125 as your answer in case of "Deduction"

In case of $ 500 tax credit:

1. The tax bill reduction is 1:1.
2. Thus the tax bill will go down by $ 500
3. Please put 500 as your answer in case of "Credit"