McGraw Hill’s Essentials of Federal Taxation 2022 Edition 13th Edition by Brian Spilker Solution ma
Surething Inc. needs to offer a 10 percent interest rate to generate a 6 percent after-tax return and make Hugh indifferent between investing in the two bonds – i.e.,
6% = Pretax return × (1 – 40%);
Pretax return = 6% / (1 – 40%) = 10%
[LO 3, LO 4 PLANNING] Fergie has the choice between investing in a State of New York bond at 5 percent and a Surething Inc. bond at 8 percent. Assuming that both bonds have the same nontax characteristics and that Fergie has a 30 percent marginal tax rate, in which bond should she invest?
Fergie’s after tax rate of return on the tax-exempt State of New York bond is 5 percent. The Surething bond pays taxable interest of 8 percent. Fergie’s after tax rate of return on the Surething bond is 5.6 percent (i.e., 8% interest income – (8% × 30%) tax = 5.6%). Fergie should invest in the Surething bond.
[LO 3, LO 4 PLANNING] Using the facts in Problem 45, what interest rate does the State of New York need to offer to make Fergie indifferent between investing in the two bonds?
To be indifferent between investing in the two bonds, the State of New York bond should provide Fergie the same after-tax rate of return as the Surething bond. Fergie’s after tax rate of return on the Surething bond is 5.6 percent (i.e., 8% interest income – (8% × 30%) tax = 5.6%). The state of New York needs to offer a 5.6 percent interest rate to generate a 5.6 percent after-tax return to make Fergie indifferent between investing in the two bonds.
[LO 3] Given the following tax structure, what minimum tax would need to be assessed on Shameika to make the tax progressive with respect to average tax rates?
Taxpayer Salary Muni-Bond Interest Total Tax
Mihwah 10,000 10,000 600
Shameika 50,000 30,000 ???
Mihwah’s average tax rate is 6 percent.
Average Tax Rate = = = 6%
A 6 percent average tax rate on Shameika’s $50,000 taxable income would result in $3,000 of tax (i.e., 6% × $50,000 = $3,000). Thus, Shameika must pay more than $3,000 tax (e.g., $3,001) for the tax structure to be progressive with respect to average tax rates.
[LO 3] Using the facts in Problem 47, what minimum tax would need to be assessed on Shameika to make the tax progressive with respect to effective tax rates?
Mihwah’s effective tax rate is 3 percent.
Effective tax rate = = = 3%
A 3 percent effective tax rate on Shameika’s $80,000 total income would result in $2,400 of tax (i.e., 3% × $80,000 = $2,400). Thus, Shameika must pay more than $2,400 tax (e.g., $2,401) for the tax structure to be progressive with respect to effective tax rates.
[LO 3, LO 5] Song earns $100,000 taxable income as an interior designer and is taxed at an average rate of 20 percent (i.e., $20,000 of tax). If Congress increases the income tax rate such that Song’s average tax rate increases from 20 percent to 25 percent, how much more income tax will she pay assuming that the income effect is descriptive? What effect will this tax rate change have on the tax base and tax collected?
Under the current income tax, Song has $80,000 of income after tax. If the income effect is descriptive and Congress increases tax rates so that Song’s average tax rate is 25 percent, Song will need to earn to $106,666.67 to continue to have $80,000 of income after tax.
After-tax income = Pretax income (1 – tax rate)
$80,000 = Pretax income (1 -.25)
Pretax income = $106,666.67
Song will pay $26,666.67 in tax ($106,666.67 × .25). Accordingly, if the income effect is descriptive, the tax base and the tax collected will increase.
The additional income tax is $26,666.67 − $20,000 = $6,666.67
[LO 3, LO 5] Using the facts from Problem 49, what will happen to the government’s tax revenues if Song chooses to spend more time pursuing her other passions besides work in response to the tax rate change and therefore earns only $75,000 in taxable income? What is the term that describes this type of reaction to a tax rate increase? What types of taxpayers are likely to respond in this manner?