Manny, a calendar-year taxpayer, uses the cash method of accounting for his sole proprietorship. In late December he performed $45,000 of legal services for a client. Manny typically requires his clients to pay his bills immediately upon receipt. Assume Manny’s marginal tax rate is 40 percent this year and next year, and that he can earn an after-tax rate of return of 10 percent on his investments.
- What is the after-tax income ifManny sends his client the bill in December?
after-tax income
- What is the after-tax income ifManny sends his client the bill in January? Use Exhibit 3.1.
after-tax-income
- Based on requirement a and b, shouldManny send his client the bill in December or January?
| December | |
| January |
- What is the after-tax income ifManny sends his client the bill in December?
after-tax income
answer:
Send 45,000 bill in the December
45,000 taxable Income *40% marginal tax rate
=18000 present Value tax
After Tax income
=pre tax income – present Value
= 450000-18000
=27000
- What is the after-tax income ifManny sends his client the bill in January? Use Exhibit 3.1.
after-tax-income
Send 45,000 bill in the January
45,000 taxable Income *40% marginal tax rate
=18000 present Value tax in year 1
Present value of Tax
=18000*0.9091(Discount factor, year 1,10%)
=$ 16363.8
After Tax income
=pre tax income – present Value
= 450000-16363.8
=28636.2
- Based on requirement a and b, shouldManny send his client the bill in December or January?
Sending 45,000 bill in the January is clear winner. Delaying invoice to January will decrease the present value of the cash flow by few days. Thus, there is minor present value cost associated with the delaying income
