Question

1.0Isabel, a calendar-year taxpayer, uses the cash method of accounting for her sole proprietorship. In late December she received a $21,000 bill from her accountant for consulting services related to her small business. Isabel can pay the $21,000 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 8 percent on her investments. What is the net cost of making the payment in December?

2. Isabel, a calendar-year taxpayer, uses the cash method of accounting for her sole proprietorship. In late December she received a $21,000 bill from her accountant for consulting services related to her small business. Isabel can pay the $21,000 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 8 percent on her investments. What is the next cost of making the payment in January?

3. Manny, a calendar-year taxpayer, uses the cash method of accounting for his sole proprietorship. In late December he performed $19,000 of legal services for a client. Manny typically requires his clients to pay his bills immediately upon receipt. Assume Manny’s marginal tax rate is 32 percent this year and next year, and that he can earn an after-tax rate of return of 8 percent on his investments. What is the net benefit of collecting the bill in December?

4.

Manny, a calendar-year taxpayer, uses the cash method of accounting for his sole proprietorship. In late December he performed $19,000 of legal services for a client. Manny typically requires his clients to pay his bills immediately upon receipt. Assume Manny’s marginal tax rate is 32 percent this year and next year, and that he can earn an after-tax rate of return of 8 percent on his investments. What is the net benefit of collecting the bill in January?

Answer 1

1) Calculation of net cost of making the payment in December

Pre Tax Bill $21,000

Marginal Tax 0.37

After tax return 0.08

PV of tax saving

Payment in December $7,770 ($21,000*0.37)

Net cost of making the payment in December $13,230 ($21,000-$7,770)

  

2) Calculation of net cost of making the payment in January

Pre Tax Bill $21,000

Marginal Tax 0.37

After tax return 0.08

PV of tax saving

  Payment in January $ 7194.44 ($21,000*0.37*1/(1+0.08)^1)

Net cost of making the payment in January $13,805.56 ($21,000-$7,194.44)

3) Calculation of net benefit of collecting the bill in December

Pre Tax Bill $19,000

Marginal Tax 0.32

After tax return 0.08

PV of tax saving

  Payment in December $ 6080 ($19,000*0.32)

Net benefit of collecting bill in December $12,920 ($19,000-$6080)

3) Calculation of net benefit of collecting the bill in January

Pre Tax Bill $19,000

Marginal Tax 0.32

After tax return 0.08

PV of tax saving

  Payment in January $ 5,629.63 ($19,000*0.32*1/(1+.08)^1)

Net benefit of collecting bill in January $13,370.37 ($19,000-$5,629.63)

It is better to collect bill in january due to net benefit of $ 450.37 ($13,370.37-$12,920)