Question

Assume that a taxpayer can choose when he is to receive $10,000 of fully taxable income. If the taxpayer receives the income at the end of Year 1, he will receive exactly $10,000. If he delays receipt of the income until the end of Year 2, the amount will grow to $11,000. If the taxpayer takes the money at the end of Year 1, he can invest the proceeds and earn a pre-tax return of 10 percent over the next year. a. If the taxpayer faces a marginal tax rate of 31 percent in both Year 1 and Year 2, when should he elect to receive the income? At what pre- tax rate of return, will the taxpayer be indifferent to taking the money in Year 1 and Year 2? If the taxpayer's marginal tax rate increases to 35 percent in Year 2, when should he elect to receive the income? d. What would the tax rate need to be in Year 2 to make the taxpayer indifferent? b. A+

Answer 1

Refer to the below images for the above asked questions, in a detailed way to solution with explanation.

& : If the tax payer faces a marginal when should he tax rate 34. clear to recove year a Realifemy in both year 1 the Income ? Anster. wer. If the tax payer takes the bonus now (at the end of year 1) after the tax amount received as & 10000 (1-0031) = 6900. The tax payer can invest this amount to earn loto before tax (6.gs. after tax) for the year which will accomulate to $6900 (1.069) - $7376.10 at the end of next year. If the taxpayer defers the bonus for one more year, the after tax amounts receaved as & 11000 (1-0031) 7590 and the tax payer is better off deferring receipt of the bonus for one more year. : the taxpayer At what pre-tax be indifferent to rate of retorn, will talking the money in year is year 2 Regrottement ore Answer: If the tax payer can earn a lot. after tax retorn on his money (a 14.4928 s. before tax retorn), he. will be indifferent to choosing the bonus at the end of year I corl the end of year a.

@ . If the toxpayer's marginal to 35 t. in year 2, when receive the income? tox rate should be increases elect to .. 31 Reapixement Answer. If the tax payer's marginal tax rate increases to 359. in year a, the $10000 bonus in year I will accomodate to $6900 (1.065) - $ 7348.50. If the bonus is deferred until the end of year 2 the taxpayey will have (11000 (1-0.35)=17150 and the taxpayer is better oft taking the $10,000 bonus at the end of year ! @ do what would the tax rate need to be in to make the kaxpayer indifferent ? year 2 Reajuirement Assuming a 101 before tax return, it rate in year 2 is equal to 33.07 of alternatives are going to be easual. the the tax payer's two Answer: = 10000 (1-0031)(1+0.10 [1-ta]) = $ Hoool1 -+a) $6900 (14 0.10 C1-ta] = $ 1000 (beta) it oolo (1-t2) = 10594203 Crta) 1.10 - oolota = 1.59 4203 - 1.59 4203 to : ta = 0.49 4203 1.494263 -0.330 747 (or) da = 33.07 %. : Tax rate in year 2 = 33.071