Reese, a calendar-year taxpayer, uses the cash method of accounting for her sole proprietorship. In late December, she received a $31,000 bill from her accountant for consulting services related to her small business. Reese can pay the $31,000 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 11 percent on her investments. a. What is the after-tax cost if she pays the $31,000 bill in December? b. What is the after-tax cost if she pays the $31,000 bill in January?

Question

Marshmallow

Business

31 May, 22:42

Reese, a calendar-year taxpayer, uses the cash method of accounting for her sole proprietorship. In late December, she received a $31,000 bill from her accountant for consulting services related to her small business. Reese can pay the $31,000 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 11 percent on her investments. a. What is the after-tax cost if she pays the $31,000 bill in December? b. What is the after-tax cost if she pays the $31,000 bill in January?

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Amelia Yu · Answer 1

a)

If Reese pays in December,

31,000*0.32 (marginal tax rate) = 9920

After tax cost = Pretax cost - Present value of tax saving = 31,000-9,920 = 21,080

b)

If Reese pays in January,

31,000*0.35 = 10,850

After tax cost = Pretax cost - Present value of tax saving = 31,000-10,850 (discount factor 1 year, 11%) = 31,000 - 10,850 * 0.9009

= 31,000 - 9,774.765 = 21,225.235