McGraw Hill’s Essentials of Federal Taxation 2022 Edition 13th Edition by Brian Spilker Solution ma

Scot and Vidia will owe $45,642 in federal income tax this year computed as follows:
 
                     $45,642 = $29,502 + 24% ($240,000 - $172,750). 

Scot and Vidia’s average tax rate is 19.02 percent.
 
Average Tax Rate = TotalTax/Taxable Income = $45,642/$240,000 = 19.02%
 
Scot and Vidia’s effective tax rate is 18.63 percent. 
 
Effective tax rate = Total Tax/Total Income = $45,642/($240,000 + $5,000) = 18.636%
 
Scot and Vidia are currently in the 24 percent tax rate bracket.  Their marginal tax rate on increases in income up to $89,850 and deductions up to $67,250 is 24 percent.
 
[LO 3] Using the facts in problem 40, if Scot and Vidia earn an additional $80,000 of taxable income, what is their marginal tax rate on this income?  How would your answer differ if they, instead, had $80,000 of additional deductions?
If Scot and Vidia earn an additional $80,000 of taxable income, their marginal tax rate on the income is 24.00 percent. 

Marginal Tax Rate = Change in Tax/Change in Taxable Income = ($64,842 -$45,642)/($320,000 - $240,000) = 24.00%
Where $64,842 for the revised tax is computed as follows: $64,842 = $29,502 + 24% ($320,000 - $172,750). 
 

If Scot and Vidia instead had $80,000 of additional tax deductions, their marginal tax rate on the deductions would be 23.68 percent.

Marginal Tax Rate = Change in Tax/Change in Taxable Income = ($26,697 -$45,642)/($160,000 - $240,000) = 23.68%
Where $26,697 for the revised tax is computed as follows: $26,697 = $9,328 + 22% ($160,000 - $81,050). 
 
[LO 3, LO 4] Melinda invests $200,000 in a City of Heflin bond that pays 6 percent interest.  Alternatively, Melinda could have invested the $200,000 in a bond recently issued by Surething Inc. that pays 8 percent interest and has risk and other nontax characteristics similar to the City of Heflin bond.  Assume Melinda’s marginal tax rate is 25 percent. 
What is her after-tax rate of return for the City of Heflin bond? 

Since the City of Heflin bond is a tax-exempt bond, Melinda’s after tax rate of return on the bond is equal to its pretax rate of return (6 percent). 
How much explicit tax does Melinda pay on the City of Heflin bond?

Since the City of Heflin bond is a tax-exempt bond, Melinda pays no explicit tax on the interest earned from the City of Heflin bond.
How much implicit tax does she pay on the City of Heflin bond? 

Melinda earns $12,000 of interest on the City of Heflin bond (i.e., 6% × $200,000).  A similar priced taxable bond (i.e., the Surething Inc. bond) would pay $16,000 of taxable interest (i.e., 8% × $200,000).  Melinda pays $4,000 of implicit tax on the City of Heflin bond (i.e., the difference between the pretax interest earned from a similar taxable bond ($16,000) and the pretax interest earned from the City of Heflin bond ($12,000)). 
How much explicit tax would she have paid on the Surething Inc. bond?

Since Melinda’s marginal tax rate is 25 percent, she would have paid $4,000 of explicit tax (i.e., 25% × $16,000) on the interest earned from the Surething, Inc. bond.
What is her after-tax rate of return on the Surething Inc. bond?


Her after-tax income from the Surething Inc. bond is $12,000 ($16,000 interest income - $4,000 tax).  Thus, her after-tax return from the Surething Inc. bond would be 6 percent (after-tax income of $12,000 divided by her $200,000 investment).


 [LO 3, LO 4 PLANNING] Hugh has the choice between investing in a City of Heflin bond at 6 percent or investing in a Surething Inc. bond at 9 percent.  Assuming that both bonds have the same nontax characteristics and that Hugh has a 40 percent marginal tax rate, in which bond should he invest?

Hugh’s after tax rate of return on the tax-exempt City of Heflin bond is 6 percent.  The Surething bond pays taxable interest of 9 percent.  Hugh’s after tax rate of return on the Surething bond is 5.4 percent (i.e., 9% interest income – (9% × 40%) tax = 5.4%).  Hugh should invest in the City of Heflin bond. 


[LO 3, LO 4 PLANNING] Using the facts in problem 43, what interest rate does Surething Inc. need to offer to make Hugh indifferent between investing in the two bonds?
 
To be indifferent between investing in the two bonds, the Surething Inc. bond should provide Hugh the same after-tax rate of return as the City of Heflin bond (6 percent).  To solve for the required pretax rate of return we can use the following formula:  After-tax return = Pretax return × (1 – Marginal Tax Rate).