Nick and Jolene are married. Nick is 61 and retired in 2012 from his job with
Amalgamated Company. Jolene is 56 and works part-time as a special education
teacher. Nick and Jolene have a substantial amount of investment savings and
would like to reorganize it to achieve the best after-tax return on their investments.
They give you the following list of projected cash receipts for 2013:
Jolene’s salary $13,000
Nick’s pension—fully taxable 12,500
Interest income 4,000
Dividend income 2,500
Social Security benefits 7,000
Farmer’s Fund annuity 6,000
In addition, Nick tells you that he owns a duplex that he rents out. The
duplex rents for 2013 are $18,000, and Nick estimates expenses of $22,000
related to the duplex. The annuity was purchased 18 years ago for $20,000, and
pays $500 per month for 10 years.
Nick and Jolene’s investments consist of the following:
6-month certificates of deposit (CDs) $100,000
1,000 shares of Lardee’s common stock (current
market value = $7 per share, projected 2013
dividend = $1 per share)—cost
10,000
2,000 shares of Corb Company common stock
(current market value = $20 per share, projected
2013 dividend = $.75 per share)—cost
20,000
a. Assuming that Nick and Jolene have total allowable itemized deductions of
$12,350 in 2013 and that they have no dependents, determine their 2013 taxable
income and tax liability based on the projections they gave you.
b. The 6-month CDs consist of two $50,000 certificates, both of which yield 4% interest.
One CD matures on January 3, 2013. Nick’s banker tells him that he can renew
the CD for one year at 4%. Nick’s stockbroker tells him that he can purchase
tax-exempt bonds with a yield of 3%. Nick would like you to determine
whether the tax-exempt bonds provide him a better after-tax return than the CD.
c. Jolene is concerned that they are not getting the best return on their Corb
Company stock. When they purchased the stock in 2002, the $.75 per share
dividend was yielding 10% before taxes. However, the rise in market value has
far outpaced the dividend growth, and it is yielding only 3.75%, based on the
current market value. Jolene thinks they should sell the stock and purchase either
the 3% tax-exempt securities or the 4% CD if it would be a better deal
from an income tax viewpoint. Calculate the tax effect on their 2013 income
of selling the shares, and determine whether they should sell the shares and
invest the after-tax proceeds in tax-exempt securities or the 4% CD. Do this
calculation after you have determined the best option regarding the CD that
matures in January.
Nick and Jolene are married, while Nick is 61 (retired from job with Amalgamated Company in the year 2012) and Jolene is 56 (Working as a part-time special education teacher). The question requires determining the taxable income and tax liability of for the year 2013.
Part a)
Statement showing Taxable Income and Tax Liability:
| S.no. | Particulars | Amount ($) |
| 1 | Jolene’s Salary | 13,000 |
| 2 | Interest Income | 4,000 |
| 3 | Dividend Income | 2,500 |
| 4 | Nick’s Pension | 12,500 |
| 5 | Farmer’s Fund Annuity | 6,000 |
| 6 | Rental Income ($ 18,000 – $ 22,000) | (4,000) |
| 7 | Social Security Benefits | 7,000 |
| 8 | Adjusted Gross Income | 41,000 |
| 9 | Itemized Deduction | 12,350 |
| 10 | Exemptions | 7,800 |
| 11 | Taxable Income | 20,850 |
| 12 | Tax Liability | 2,239 |
Part b)
Statement showing after tax return under both the options:
| Particulars | Certificate of Deposit | Tax-Exempt Bonds |
| Amount | 100,000 | 1,00,000 |
| Interest Rate | 4% | 3% |
| Interest | 4,000 | 3,000 |
| Tax @ 10.74% | 430 | 0 |
| After-tax interest | 3,570 | 3,000 |
| Percentage return | 3.57% | 3.00% |
Hence, Certificate of deposits provide a better return
Part c)
As per part b) calculations, the best returns are provided by CDs and hence, the sales proceeds will be invested in the same.
| S.no. | Particulars | Amount ($) |
| 1 | Jolene’s Salary | 13,000 |
| 2 | Interest Income (4,000 + (20,000 x 4%)) | 4,800 |
| 3 | Dividend Income | 1,000 |
| 4 | Nick’s Pension | 12,500 |
| 5 | Farmer’s Fund Annuity | 6,000 |
| 6 | Rental Income ($ 18,000 – $ 22,000) | (4,000) |
| 7 | Social Security Benefits | 7,000 |
| 8 | Capital Gain on sale of shares (2,000 x ($ 20 – $ 10) | 20,000 |
| 9 | Adjusted Gross Income | 60,300 |
| 10 | Itemized Deduction | 12,350 |
| 11 | Exemptions | 7,800 |
| 12 | Taxable Income | 40,150 |
| 13 | Tax Liability | 5,126 |
Statement showing after tax return under both the options:
| Particulars | Investment in Corb Company | Investment in CD |
| Dividend Income | 1,500 | – |
| Interest Income | – | 800 |
| Investment | 20,000 | 20,000 |
| Return % | 7.50% | 4.00% |
It is recommended not to sell the shares.
Notes:
- It has been assumed that the social security benefits received are taxable
- Tax rate = $ 2,239 / $ 20,850 = 10.74%
