Question

Ms. Z has decided to invest $75,000 in state bonds. She could invest in State A bonds paying 5 percent annual interest or in State R bonds paying 5.4 percent annual interest. The bonds have the same risk, and the interest from both is exempt from federal income tax. Because Ms. Z is a resident of State A, she wouldn’t pay State A’s 8.5 percent personal income tax on the State A bond interest, but she would pay this tax on the State R bond interest. Ms. Z can deduct any state tax payments in the computation of her federal taxable income, and her federal marginal rate is 32 percent.

Compute Ms. Z's after-tax return from State A and State R bonds.

Compute Ms. Z's after-tax return from State A and State R bonds. (Enter costs with a minus sign. Round your intermediate computations and final answers to the nearest whole dollar amount.)

State A
Before-tax return	$
State A income tax	$
Federal tax savings from deduction of state income tax	$
After-tax return	$
State R
Before-tax return	$4,050correct
State R income tax	(344) correct
Federal tax savings from deduction of state income tax	110 correct
After-tax return	$3,816

Answer 1

State A
Before-tax return (75,000 * 5%)	$3,750
State A income tax	$0
Federal tax Savings from deduction of state income tax	$0
After-tax return	$3,750

                    Ms. Z is a resident of State A. So, she need not pay 8.5% personal income tax on state A. If income tax is zero, no federal tax savings is possible.

State R
Before-tax return (7,5000 * 5.4%)	$4,050
State R income tax (4,050 * 8.5%)	-$344
Federal tax savings from deduction of state income tax (344 * 32%)	110
After-tax return	$3,816