Question

Hank, a calendar-year taxpayer, uses the cash method of accounting for his sole proprietorship. In late...

Hank, a calendar-year taxpayer, uses the cash method of accounting for his sole proprietorship. In late December, he performed $22,000 of legal services for a client. Hank typically requires his clients to pay his bills immediately upon receipt. Assume his marginal tax rate is 32 percent this year and will be 37 percent next year, and that he can earn an after-tax rate of return of 5 percent on his investments.

a. What is the after-tax income if Hank sends his client the bill in December?

b. What is the after-tax income if Hank sends his client the bill in January? Use Exhibit 3.1. (Round your answer to the nearest whole dollar amount.)

c. Based on requirement a and b, should Hank send his client the bill in December or January?

Homework Answers

Answer #1

Send the $22,000 bill in December $22,000 taxable income x 32 percent marginal tax rate = $7040 in present

value tax

After-tax income = Pretax income - Present Value Tax

= $22,000 - $7040 = $14960

Option 2 Send the $22,000 bill in January $22,000 taxable income x 37 percent marginal tax rate = $8,140 in tax in one

year

Present Value of Tax = $8,140 x.952 (Discount Factor, 1 Year,5

percent)

= $7750

After-tax income = Pretax income - Present Value Tax

= $22,000 -

$7,750 = $14250

Sending the $22000 bill in December is the clear winner.

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