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There are 50 total points for this assignment. The point value of each exercise is determined by dividing the 50 points
by the number of exercises per assignment.
If you have difficulty with any of the exercieses, take advantage of the collaboration discussion forum.
3 Returns on alternative saving vehicles
4 Choosing the optimal organizational form 1, 3 Chapter 3
12 Exercise 4 deductions Points earned
12 4. Suppose a taxpayer, when 25 years old, made one tax-deductible $2,000 contribution of her after-tax salary to a
deductible IRA. Her investment (taxable corporate bonds) earned a 12% annual return, and she liquidates the
investment 10 years later when she retires. Her tax rate is 35%, but she must pay an additional 10% excise tax
because she liquidates the IRA before she reaches the age 59.5.
a. After taxes, how much cash does she have when she liquidates the IRA?
b. Was it a mistake for the taxpayer to have set up an IRA?
What would she have earned had she invested her after-tax salary in the taxable corporate bonds directly instead
of through an IRA? a. Note, the taxpayer deposits $2,000 into the pension which is tax deductible implying a pretax contribution of
contribution x (1- current Tax rate = pretax contributio. To earn points you must show your formula below>
2000(1-35%)=1300 <-- answer create a formula use the above information to create an equation to calculate the pretax contribution
The $2000 above will grow at 12% for 10 years.
Ok, create a formula to calculate the after-tax accumulation - you must show the formula to earn points.
pretax contribution x (1+.12)10 x (1-.45).
The .45 is required because there is an early withdrawal penalty.
In order to calculate the (1+.12)10 click on the function (fx) symbol to the left of the formula bar above. Type
in the word power and follow the instructions. 2220.68132 <-- answer and formula b. Was it a mistake for the taxpayer to have set up an IRA? b. We need to make sure are comparing the same after-tax initial investments. In the
pension we put $1,300 after-tax or $2,000 pretax. If we invest directly in the bonds, we
can only invest $1,300 of after-tax dollars. Thus
1300(1 + .12(1-.35))10 = $n,nnn
Was it a mistake? Yes or no Exercise 5 points possible
12 <-- answer and formula
yes <-- answer deductions Points earned
12 5. A taxpayer is about to receive a $1,000 bonus payment from his employer. He would like to put this bonus into a
retirement account. He has come to you for advice as to whether he should put the $1,000 into a traditional
deductible IRA or a Roth IRA account.
You learn that he faces a current marginal tax rate of 28% and expects to face the same rate in 40 years, when he
plans to withdraw the funds at age 70. He expects to earn a pretax rate of return of 10% in either retirement
account by investing the funds in corporate bonds.
Advise the taxpayer as to what he should do. First, we must calculate the amount that will be earned during the 40 years for each investment.
Deductible IRA ($1000/(1-Tax Rate)) x (1+ earnings rate)40 x (1-tax rate) 45259.2555682
Roth IRA <-- answer and formula
1000(1+ Earnings rate) 40 45259.2555682 <-- answer and formula Advise the taxpayer as to what he should do. type advise here: If the tp expected the taxrate to increase, the Roth
would be favored because it is tax exempt. It is the same accumulation.
With the Roth, you pay taxes upfront and none when you retire. In the
traditional the taxes are deferred in the end. If you can afford to be taxed
now, when you're older you won't get hit with the Roth. Chapter 4
13 Exercise 1 deductions Points earned
13 1. Suppose that the tax rate on personal income, tp, is equal to 40%; the corporate tax rate, tc, is equal to 35%; and
the capital gains tax rate, tcg, is 20%. Also assume that the before-tax rate of return on investment to both the
corporate and partnership form is 15% per year. These tax rates and investment returns are constant over time. On
the basis of these facts, identify the following as true or false. (Support your answers with numerical examples.)
a. The annualized after-tax rate of return to investing in the corporate form increases with the length of the investor?s
holding period. Explain.
b. The annualized after-tax rate of return to investing in the partnership form increases with the length of the
partner?s holding period. Explain.
c. If a corporation paid out its entire after-tax profits as fully taxable dividends each year, shareholders would realize
a lower before-tax rate of return than if the corporation retained the after-tax profits. Explain.
d. Because the corporate tax rate is below the personal tax rate, the corporate form is always preferred to the
e. Because corporate income is subject to two levels of taxation, the partnership form is always preferred to the
corporate form. a. 1 <-answer true or false $1[1+R(1-tc)] (1-tcg) + tcg$1
Remember that the corporate form allows the invester to defer capital gains until the stock is sold.
tc = .35
Tcg = .20
superscript n = period
n Create a formula or formulas and combine them to determine the after-tax rate of return for each peirod.
You will need to calculate the result 3 time - once for each period.
show formulas below
Review the cells to understand the formulas
The first period is completed for you. Use these formulas as a model for period 5 and 10
rate of return for each period
7.80% <-- answer
45.31% <-- answer
1 111.10% <-- answer b. <-answer true or false Calculations See 4.1 $1[1 + R(1 - tp)]n For partnership investments, all taxes are paid annually, so the investment horizon does not affect the annual rate of return.
Create a formula or formulas and combine them to determine the annual partnership rate of return.
The formula above simplies to = R(1 ? tp). <-- answer c. <-answer true or false
type your response here. show your formulas below d. <-answer true or false type your response here.
What is double taxation? and compare part a and b above. You must explain here to
earn points. e.
Calculations <-answer true or false type your response here.
How does deferred taxes (capital gains) impact the longterm tax rate of the
corporation? You must explain here to earn points. Chapter 4
13 Exercise 3 deductions Points earned
13 3. A taxpayer capitalizes a wholly owned corporation with $100,000. The corporation invests in a project that
earns an annual pretax rate of return of 15% and faces a 15% corporate tax rate. The taxpayer faces a personal tax
rate of 39.6% and expects to liquidate the corporation after 20 years.
a. What is the after-tax rate of return on this investment?
b. Do you recommend that the taxpayer make this investment via an S corporation to avoid double taxation?
Assume the corporation distributes enough cash to the taxpayer each year to allow him to pay his taxes on the S
corporation income. a.
Note here assuming that the capital gains tax rate equals the personal tax rate on ordinary income
of 39.6%. The after-tax accumulation in the corporation is given by
Calculations See 4.2 $1[1+R(1-tc)]n (1-tcg) + tcg$1 R=.15 tc = .15 tcg = .396 Refer to exercise 1 above part a in order to create the formula or formulas to solve this problem
To calculate the after-tax rate of return
the result from the first calculation divided by $100,000 to the power of 1/years
Calculate the after tax return to the S corp. and compare to your return in part a.
=tc(1-tcg) You must explain here to earn points.
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