Question & Answer

Komiko Tanaka invests $12,000 in LymaBean, Inc. LymaBean does not pay any dividends.  Komiko projects that her investment will generate a 10 percent before-tax rate of return.  She plans to invest for the long term.

a.   How much cash will Komiko retain, after-taxes, if she holds the investment for 5 years and then she sells it when the long-term capital gains rate is 15 percent?

b.   What is Komiko’s after-tax rate of return on her investment in part (a)?

c.   How much cash will Komiko retain, after-taxes, if she holds the investment for 5 years and then sells when the long-term capital gains rate is 25 percent?

d.   What is Komiko’s after-tax rate of return on her investment in part (c)?

e.   How much cash will Komiko retain, aftertaxes, if she holds the investment for 15 years and then she sells when the long-term capital gains rate is 15 percent?

f.    What is Komiko’s after-tax rate of return on her investment in part (e)?

Irene is saving for a new car she hopes to purchase either four or six years from now.  Irene invests $10,000 in a growth stock that does not pay dividends and expects a 6 percent annual before-tax return (the investment is tax deferred).When she cashes in the investment after either four or six years, she expects the applicable marginal tax rate on long-term capital gains to be 25 percent. 

a.       What will be the value of this investment four and six years from now?

b.      When Irene sells the investment, how much cash will she have after taxes to purchase the new car (four and six years from now)?

Anne’s marginal income tax rate is 30 percent.  She purchases a corporate bond for $10,000 and the maturity, or face value, of the bond is $10,000.  If the bond pays 5 percent per year before taxes, what is Anne’s annual after-tax rate of return from the bond if the bond matures in one year?  What is her annual after-tax rate of return if the bond matures in 10 years?

Helen holds 1,000 shares of Fizbo Inc. stock that she purchased 11 months ago. The stock has done very well and has appreciated $20/share since Helen bought the stock. When sold, the stock will be taxed at capital gains rates (long-term rate is 15% and short-term rate is the taxpayer’s marginal tax rate). If Helen’s marginal tax rate is 35%, how much would she save by holding the stock an additional month before selling? What might prevent Helen from waiting to sell?

} Dennis is currently considering investing in municipal bonds that earn 6 percent interest, or in taxable bonds issued by the Coca-Cola Company that pay 8 percent.  If Dennis’ tax rate is 20 percent, which bond should he choose?  Which bond should he choose if his tax rate is 30 percent?  At what tax rate would he be indifferent between the bonds?  What strategy is this decision based upon?

Daniel is considering selling two stocks that have not fared well over recent years. A friend recently informed Daniel that one of his stocks has a special designation, which allows him to treat a loss up to $50,000 on this stock as an ordinary loss rather than the typical capital loss. Daniel figures that he has a loss of $60,000 on each stock. If Daniel’s marginal tax rate is 35 percent and he has $120,000 of other capital gains (taxed at 15 percent), what is the tax savings from the special tax treatment

Using the facts in the previous problem, what are some ways that Bendetta could shift some of the rental income to Jenine?  What are the disadvantages associated with these income-shifting strategies?

Bendetta, a high-tax-rate taxpayer, owns several rental properties and would like to shift some income to her daughter, Jenine.  Bendetta instructs her tenants to send their rent checks to Jenine so Jenine can report the rental income.  Will this shift the income from Bendetta to Jenine?  Why or why 

Hyundai is considering opening a plant in two neighboring states.  One state has a corporate tax rate of 10 percent.  If operated in this state, the plant is expected to generate $1,000,000 pretax profit.  The other state has a corporate tax rate of 2 percent.  If operated in this state, the plant is expected to generate $930,000 of pretax profit.  Which state should Hyundai choose?  Why do you think the plant in the state with a lower tax rate would produce a lower before-tax income?  

incorporating their sole proprietorship.  Using the married-joint tax brackets an]{Planning}Orie and Jane, husband and wife, operate a sole proprietorship.  They expect their taxable income next year to be $300,000, of which $125,000 is attributed to the sole proprietorship.  Orie and Jane are contemplating d the corporate tax brackets, find out how much current tax this strategy could save Orie and Jane.  How much income should be left in the corporation?

Moana is a single taxpayer who operates a sole proprietorship.  She expects her taxable income next year to be $250,000, of which $200,000 is attributed to her sole proprietorship.  Moana is contemplating incorporating her sole proprietorship.  Using the single individual tax brackets and the corporate tax brackets, find out how much current tax this strategy could save Moana (ignore any Social Security, Medicare, or self-employment tax issues).  How much income should be left in the corporation?

Tawana owns and operates a sole proprietorship and has a 40 percent marginal tax rate.  She provides her son, Jonathon, $8,000 a year for college expenses.  Jonathon works as a pizza delivery person every fall and has a marginal tax rate of 15 percent. 

a. What could Tawana do to reduce her family tax burden? 

b.How much pretax income does it currently take Tawana to generate the $8,000 after-taxes given to Jonathon? 

c. If Jonathon worked for his mother’s sole proprietorship, what salary would she have to pay him to generate $8,000 after taxes (ignoring any Social Security, Medicare, or self-employment tax issues)? 

d.How much money would this strategy save?  

Bob’s Lottery, Inc., has decided to offer winners a choice of $100,000 in ten years or some amount currently.  Assume that Bob’s Lottery, Inc., earns a 10 percent after-tax rate of return.  What amount should Bob offer lottery winners currently, in order for him to be indifferent between the two choices?

Jonah has the choice of paying Rita $10,000 today or $40,000 in ten years.  Assume Jonah can earn a 12 percent after-tax rate of return.  Which should he choose?

} Assume Ellina earns a 10 percent after-tax rate of return, and that she owes a friend $1,200.  Would she prefer to pay the friend $1,200 today or $1,750 in four years?

Assume Rafael can earn an 8 percent after-tax rate of return.  Would he prefer $1,000 today or $1,500 in five years? 

Answer:

Geraldo recently won a lottery and chose to receive $100,000 today instead of an equivalent amount in ten years, computed using an 8 percent rate of return.  Today, he learned that interest rates are expected to increase in the future.  Is this good news for Geraldo given his decision?

Using the facts from the previous problem, when should Hank send the bill if he expects his marginal tax rate to be 33 percent next year? 25 percent next year?

} Hank, a calendar-year taxpayer, uses the cash method of accounting for his sole proprietorship.  In late December he performed $20,000 of legal services for a client.  Hank typically requires his clients to pay his bills immediately upon receipt.  Assume his marginal tax rate is 30 percent this year and will be 40 percent next year, and that he can earn an after-tax rate of return of 12 percent on his investments.  Should Hank send his client the bill in December or January? 

Using the facts from the previous problem, when should Reese pay the bill if she expects her marginal tax rate to be 33 percent next year? 25 percent next year?

} Reese, a calendar-year taxpayer, uses the cash method of accounting for her sole proprietorship.  In late December she received a $20,000 bill from her accountant for consulting services related to her small business.  Reese can pay the $20,000 bill any time before January 30 of next year without penalty.  Assume Reese’s marginal tax rate is 30 percent this year and will be 40 percent next year, and that she can earn an after-tax rate of return of 12 percent on her investments.  When should she pay the $20,000 bill—this year or next?

} Using the facts from the previous problem, how would your answer change if Manny’s after-tax rate of return were 8 percent?

Manny, a calendar-year taxpayer, uses the cash method of accounting for his sole proprietorship.  In late December he performed $20,000 of legal services for a client.  Manny typically requires his clients to pay his bills immediately upon receipt.  Assume Manny’s marginal tax rate is 40 percent this year and next year, and that he can earn an after-tax rate of return of 12 percent on his investments.  Should Manny send his client the bill in December or January?

Using the facts from the previous problem, how would your answer change if Isabel’s after-tax rate of return were 8 percent?

Isabel, a calendar-year taxpayer, uses the cash method of accounting for her sole proprietorship.  In late December she received a $20,000 bill from her accountant for consulting services related to her small business.  Isabel can pay the $20,000 bill anytime before January 30 of next year without penalty.  Assume her marginal tax rate is 40 percent this year and next year, and that she can earn an after-tax rate of return of 12 percent on her investments.  When should she pay the $20,000 bill—this year or next?