Question

Hank, a calendar-year taxpayer, uses the cash method of accounting for his sole proprietorship. In late December, he performed $22,000 of legal services for a client. Hank typically requires his clients to pay his bills immediately upon receipt. Assume his marginal tax rate is 32 percent this year and will be 35 percent next year, and that he can earn an after-tax rate of return of 12 percent on his Investments. Use Exhibit 3.1. a. What is the after-tax income if Hank sends his client the bill in December? After-tax income b. What is the after-tax income if Hank sends his client the bill in January? (Do not round Intermediate calculations. Round your answer to the nearest whole dollar amount.) After-tax income c. Should Hank send his client the bill in December or January? December January d. What is the after-tax income if Hank expects his marginal tax rate to be 24 percent next year and sends his client the bill in January? (Do not round Intermediate calculations. Round your answer to the nearest whole dollar amount.) After-tax income e. Should Hank send his client the bill in December or January if he expects his marginal tax rate to be 32 percent this year and 24 percent next year? December O January

Answer 1

solution a. $14,960

explanation : AFTER TAX INCOME IF bill sends in December

= Pre tax income - tax

= $22,000 - ($22,000 x 32 %)

=$22,000 - $7040

=$14,960

solution b. 15123.9 or 15124 (rounded)

explanation: if bill sends in jan. then tax rate is 35%

Tax = ($22,000 x 35 %) = $7700

present value of tax = $7700 x PVIF (12% , 1 YEAR)

= $7700 X 0.893

= 6876.1

[learning notes :(we calculate present value becasue we calculate future income(january ) in present (december) ]

After tax income = Pre tax income - present value of tax

= $22,000 - $6876.1

= 15123.9 or 15124 (rounded)

solution c.january

explanation : in january because proceeds are more in jan compare to december.

Solution d. $17284.96 or $17285 (rounded)

explanation :

tax = $22,000 x 24 % = $5280

present value of tax = $5280 x PVIF (12% , 1 YEAR)

=$5280 x 0.893

= $4715.04

After tax income = Pre tax income - present value of tax

= $ 22000 - $4715.04

= $17284.96 or $17285 (rounded)

Solution e : january

explanation : in january because proceeds are more in jan compare to december.

[learning notes : in cash system we record transaction when payment is made or received so here we apply same logic]

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