Tonya, who lives in California, inherited a $100,000 State of California bond in 2018. Her marginal Federal tax rate is 35%, and her marginal state tax rate is 5%. The California bond pays 3.3% interest, which is not subject to California income tax. She can purchase a corporate bond of comparable risk that will yield 5.2% or a U. S. government bond that pays 4.6% interest. Hint: Don't forget to calculate any potential federal tax savings from a deduction from CA state taxes. What is the after-tax income form each bond?

Question

Nathanael Garrison

Business

11 September, 21:09

Tonya, who lives in California, inherited a $100,000 State of California bond in 2018. Her marginal Federal tax rate is 35%, and her marginal state tax rate is 5%. The California bond pays 3.3% interest, which is not subject to California income tax. She can purchase a corporate bond of comparable risk that will yield 5.2% or a U. S. government bond that pays 4.6% interest. Hint: Don't forget to calculate any potential federal tax savings from a deduction from CA state taxes. What is the after-tax income form each bond?

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Talia · Answer 1

after tax income from corporate bond = 3.211%

Explanation:

given data

State of California bond = $100,000

marginal Federal tax rate = 35%

marginal state tax rate = 5%

interest = 3.3%

yield = 5.2%

Interest payment = 4.6%

solution

we get here after tax income from U. S. Government Bond that is

after tax income from U. S. Government Bond = Interest rate * (1 - marginal Federal Tax) ... 1

put here value

after tax income from U. S. Government Bond = 4.6% * (1 - 35 %)

after tax income from U. S. Government Bond = 2.99%

and

California Bond Interest not subject to California Income tax

so most California state bonds are exempt from both Federal and California State Income Tax

but certain bond is not meet all tax exempt rule

so in some cases Federal Tax may be applicable

so here in this case

we have give interest not subject to California Income tax

so Federal Tax is applicable

after tax income will be = 3.3% * (1 - 35%)

after tax income = 2.145%

and

If Federal Tax is not applicable

then after-tax income = 3.3%

so

Corporate Bond Both California state tax and Federal Tax are applicable

so tax payer is claim deduction either state income tax or state sales tax

in itemize deduction for Federal Tax purpose

so effective

combined State and Federal Tax rate = Marginal State Tax rate + Marginal Federal tax rate * (1 - Marginal State Tax rate) ... 2

combined State and Federal Tax rate = 5% + 35% * (1 - 5%)

combined State and Federal Tax rate = 38.25%

so that

after tax income from corporate bond is = 5.2% * (1 - 38.25%)

after tax income from corporate bond = 3.211%