Manny, a calendar-year taxpayer, uses the cash method of accounting for his sole

Question

Manny, a calendar-year taxpayer, uses the cash method of accounting for his sole proprietorship. In late December he performed $40,000 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 5 percent on his investments.

a. What is the after-tax income if Manny sends his client the bill in December?

b. What is the after-tax income if Manny sends his client the bill in January?

c. Based on requirement a and b, should Manny send his client the bill in December or January?

Explanation / Answer

a) If bill is send in December:

Amount to be received = 40000 $

Tax rate = 40%

Net amount = 40000 – 40000*.40 = 24000 $

b) If bill is send in Jan:

Amount to be received = 40000 $

Tax rate = 40% = 40000*.40 = 16000

Present value = 16000/1.05 = 15238.10

Net amount = 40000 – 15238.10= 24761.9 $

c) Manny send his client the bill in January as it has higher cash flow.

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