The incremental marginal tax rate for both state and federal corporate income ta
ID: 1217564 • Letter: T
Question
The incremental marginal tax rate for both state and federal corporate income taxes is found by the equation: Combined Tax Rate = Delta%S + Delta%F(1 - Delta%S) where Delta%S is the state marginal tax rate and Delta%F is the federal marginal tax rate. The increase in taxes paid is found by the equation: Increase in Taxes Paid = DeltaM. [Deta%S + Delta%F(1 - Deta%S)] where DeltaM is the increase in taxable income earned by the corporation. Even though it is negligible, the higher is the state corporate income tax rate, the more that is paid in total corporate income taxes (both state and federal). States with higher corporate income tax rates, however, allow companies to deduct more from their taxable income, creating a smaller taxable income base (so that the taxable income base is (DeltaM - State Specific Tax Write - Offs)). Suppose that a company is deciding between Nevada (with no corporate income tax) and California (with an 8.8% corporate income tax). If the company is in the 34% federal tax bracket (the highest), and will remain there, and cams $10,000,000 in additional income, for the company to be indifferent between California and Nevada what is the taxable base that California will tax on?Explanation / Answer
Let us first calculate what is the Increase in Taxes Paid in Nevada where there is no corporate income tax
So in Nevada
Increase in taxes Paid = 10,000,000 * [0% + 34% * (1-0%)]
Increase in taxes Paid = 10,000,000 * [0% + 34% * 1]
Increase in taxes Paid = 10,000,000 * [0% + 34% ]
Increase in taxes Paid = 10,000,000 * 34%
Increase in taxes Paid = 3,400,000
Lets calculate tax base in California, by assuming it as X
So in California
Increase in taxes Paid = X * [8.8% + 34% * (1-8.8%)]
Increase in taxes Paid = X * [8.8% + 34% * (91.2%)]
Increase in taxes Paid = X * [8.8% + 31%]
Increase in taxes Paid = X * [39.8%]
Increase in taxes Paid should be same in 2 states, so Increase in taxes Paid is 3,400,000
3,400,000 = X * [39.8%]
X = 3,400,000 / 39.8% = 8,540,996.78
This has to be the taxable base in California
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