Reese, a calendar-year taxpayer, uses the cash method of accounting for her sole

Question

Reese, a calendar-year taxpayer, uses the cash method of accounting for her sole proprietorship. In late December, she received a $40,000 bill from her accountant for consulting services related to her small business. Reese can pay the $40,000 bill anytime before January 30 of next year without penalty. Assume Reese's marginal tax rate is 32 percent this year and 35 percent next year, and that she can earn an after-tax rate of return of 9 percent on her investments. a. What is the after-tax cost if she pays the $40,000 bill in December? After-tax cost b. What is the after-tax cost if she pays the $40,000 bill in January? Use Exhibit 31. (Do not round intermediate calculations. Round your answer to the nearest whole dollar amount.) After-tax cost c. Should Reese pay the $40,000 bill in December or January? January December d. What is the after-tax cost if she expects her marginal tax rate to be 24 percent next year and pays the $40,000 bil in January? Use Exhibit 31. (Round your answer to the nearest whole dollar amount.) After-tax cost e. Should Reese pay the $40,000 bill in December or January if she expects her marginal tax rate to be 32 percent this year and 24 percent next year?

Explanation / Answer

a) If Pay $40000 Bill in December :-

Present Value of Tax Saving = Tax Deduction * Marginal Tax Rate

= $40000 * 32%

= $12800

After Tax Cost = Pretax Cost - Present Value tax Saving

= $40000 - $12800

= $27200

b) If Pay $40000 bill in January :-

Tax Saving in one year = Tax Deduction * Marginal Tax Rate

= $40000 * 35%

= $14000

Present Value of Tax saving = $14000 * (1/1.09)

= $14000 * 0.91743

= $12844

After Tax Cost = $40000 - $12844

= $27156

c) Should Reese Pay the $40000 bill in January.

d) If Pay $40000 bill in January :-

Tax Saving in one year = Tax Deduction * Marginal Tax Rate

= $40000 * 24%

= $9600

Present Value of Tax Saving = $9600 * 0.91743

= $8807

After Tax Cost = Pretax Cost - Present Value Tax Savings

= $40000 - $8807

= $31193

E) Should Reese Pay the $40000 bill in December.

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