Interest versus dividend income During the year just ended, Shering Distributors

Question

Interest versus dividend income During the year just ended, Shering Distributors,
Inc., had pretax earnings from operations of $490,000. In addition, during the year
it received $20,000 in income from interest on bonds it held in Zig Manufacturing
and received $20,000 in income from dividends on its 5% common stock holding in
Tank Industries, Inc. Shering is in the 40% tax bracket and is eligible for a 70% dividend
exclusion on its Tank Industries stock.
a. Calculate the firm’s tax on its operating earnings only.
b. Find the tax and the after-tax amount attributable to the interest income from
Zig Manufacturing bonds.
c. Find the tax and the after-tax amount attributable to the dividend income from
the Tank Industries, Inc., common stock.
d. Compare, contrast, and discuss the after-tax amounts resulting from the interest
income and dividend income calculated in parts b and c.
e. What is the firm’s total tax liability for the year?

Explanation / Answer

(a) The firm's operating income is $490,000.

So, tax on operating earnings = $490,000 x 40% = $196,000

(b) Tax on interest received = $20,000 x 40% = $8,000

Post-tax interest income = $20,000 x 60% = $12,000

(c) Dividend exclusion is 70%.

So, tax on dividend = Amount of dividend x 30%

= $20,000 x 30% = $6,000

After-tax dividend = $20,000 x 70% = $14,000

(d) Even though amount of interest received and dividend received are the same, after-tax dividend is much higher than after-tax interest. This is because, interest is charged at the standard income tax rate but dividend is charged at a lower rate (100% - dividend exclusion of 70%).

(e) Firm's total tax liability = $(196,000 + 8,000 + 6,000) = $210,000

Related Questions

Navigate

• Browse (All)
• Browse I
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.