Question

2. Suppose a tax payer faces a federal marginal income tax rate of 25% and pays local property taxes of $2,000 per year.

a. Assume the taxpayer itemizes federal deductions and, thus, deducts the local property tax. No state income tax deduction for local taxes exists. What is the net after-tax cost of property taxes to this taxpayer? (2 points)

b. Suppose the state introduces an income tax credit of 25% of property taxes up to a maximum of $600. What is the taxpayer’s net property tax cos now? (Remember that the state income tax is also deducted against the federal tax.) How much does the net cost fall because of the credit? (2 points)

Answer 1

a).The Tax Payer has wrongly taken the local property tax paid as a deduction for calculating federal income tax. Therefore, The Tax Payer has to pay the wrongly taken deduction. Amount he is required to pay = 2000*25% = $ 500

b). If the State Government introduces an Income tax credit of 25 % of property tax upto a maximum of $600. Then, the Tax payer's net Property tax cost = 2000- 25% of 2000 =2000-500 = $ 1500. The net cost has fallen by $ 500 because of the credit.