2-4 Interest versus dividend income During the year just ended, Shering Distribu

Question

2-4 Interest versus dividend income During the year just ended, Shering Distributors, Inc., had pretax earnings from operations of $490,000. In addition, during the year it received $20,000 in income from interest on bonds it held in Zig Manufacturing and received $20,000 in income from dividends on its 5% common stock holding in Tank Industries, Inc. Shering is in the 40% tax bracket and is eligible for a 70% div idend exclusion on its Tank Industries stock. a. Calculate the firm's tax on its operating earnings only Find the tax and the after-tax amount attributable to the interest income from Zig Manufacturing bonds Find the tax and the after-tax amount attributable to the dividend income from the Tank Industries, Inc., common stock. d. Compare, contrast, and discuss the after-tax amounts resulting from the interest income and dividend income calculated in parts b and c. e. What is the firm's total tax liability for the year?

Explanation / Answer

1:Tax on operating earnings= Net Income*Tax rate

= 490000*40% = $196000

2: Tax on Interest income= Interest income*tax rate

= 20000*40% = $ 8000

After tax interest= 20000- 8000 = $12,000

3: Tax on dividend= Dividend amount*(1-Exclusion)* Tax rate

= 20000*(1-70%)*40% = $2400

After tax dividend= 20000-2400 = $17600

4: The operating income and interest is taxed in the same manner. However due to dividend exclusion, the company enjoys lesser tax on dividend receipts which makes the after tax earnings from dividend the highest.

5: Total tax = Tax on (Operating earnings+interest+ dividend)

196000+8000+2400

= 206400

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