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Taxes

VIEWS: 35 PAGES: 17

									LECTURE 5
Taxes •Chapter 2 Problems
•

Federal Income Tax System
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The Federal Tax Code is separated into two sections:
1.

Tax laws that are applicable to individuals
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Proprietorships and partnerships are taxed as individuals

2.

Tax laws that are applicable to corporations
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Individual Income taxes
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Taxable income = Gross income minus exemptions and allowable deductions (indicated in notes to Appendix, e.g. $2,750 per dependent) Marginal tax rate = Tax on the last unit of income (e.g. 28% for $50,000 taxable income) Average tax rate = taxes paid divided by taxable income (e.g. 18.4% for $35,000)
1-3

Appendix 2-A
Tax Rates for 1999 Unmarried tax payers, not Heads of Households Taxable Income Bracket $ 1 --- 25,750 25,751 --- 62,450 62,451 --- 130,250 130,251 --- 283,150 Above 283,150 Base Tax Amount 0 3,862.50 14,138.50 35,156.50 90,200.50 + + + + + Plus this percent of the Average Tax rate at the Top of the Bracket Amount over 15% 28% 31% 36% 39.60% 0 25,750 62,450 130,250 283,150 15% 22.60% 27% 31.90% 40%

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Taxes on dividend and interest income
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Added to other income and taxed Interest on local govt bonds is not subject to federal income taxes A lower yielding tax-free govt bond can provide the same after-tax return as a higher-yielding corporate bond

1-5

Taxes on dividend and interest income…
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Yield on tax-free investment = (Pretax yield on taxable investment) x (1 — Marginal tax rate) 6% = 8.7% x (1 — 0.31)

1-6

Interest paid by individuals
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It is NOT tax deductible However, interest paid on mortgage financing used to purchase a house for personal residence is tax deductible

1-7

Tax on Capital gains
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Capital assets: Assets such as stocks, bonds and real estate are capital assets Capital gain: The profit from the sale of a capital asset for more than its purchase price Capital loss: The loss from the sale of a capital asset for less than its purchase price For assets held for < 1 year = marginal tax rate For assets held for > 1 year = 20%
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Business vs. Personal expenses
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Personal expenses are not tax deductible Business expenses are tax deductible E.g. Kay gets plumbing fixed in a house that she has rented out. The repairs cost $1,200. This is a tax deductible expense
1-9

Corporate Income Taxes
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Interest and dividend income received by a corporation
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Interest income is taxed as ordinary income 70% of the dividend income is excluded from taxable income For $10,000 in dividend income, the after-tax income is $8,950 After tax income = before-tax income minus taxes = 10,000 – [10,000(0.30)] (0.35) = $8,950
1-10

Interest and Dividends paid
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Interest paid is deductible from operating income to obtain taxable income Dividends paid are not deductible from operating income Therefore, a firm needs $1 of pretax income to pay $1 of interest. But you need more than $1 of pretax income to pay $1 dividends (you need $1.54 pretax income)
1-11

Dividends paid …
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Pretax income needed to pay $1 of dividends = $1 / (1— Tax rate) Tax rate = 35% = 1/ (1—0.35) = $1.54

1-12

Corporate Loss Carryback and Carryover
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Ordinary corporate operating losses can be carried back (carryback) to each of the preceding two years and carried over (carryover) for the next 20 years to offset future taxable income Purpose:
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Avoid penalizing corporations whose incomes fluctuate substantially from year to year Makes it more feasible for large multidivisional corporations to undertake risky new ventures
1-13

Apex Corporation: Partial Income Statements for 1998 to 2000 ($ mn) 1998 1999 2000 2001 2001 Carryforward Original statement:
Taxable income Taxes (35%) Net Income


260 (91) 169

180 (63) 117

(700) 245 (455)

260 260 (260) (91) 169 0

credit

Tax refund plus tax saving = 154 + 91 = 245
1998
260

Taxable income

Adjusted statement: Original taxable income

1999
180

Total effect of carryback

Carry-back credit (260) (180) $440 Adjusted taxable income 0 0 Taxes (35%) 0 0 Adjusted net income 0 0 Taxes originally paid 91 63 $154 = Tax refund Loss available to carry forward in 2001-2020 = $700 -- $440 = $260

S Corporation
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Small business that elects to be taxed as a proprietorship or a partnership yet retains limited liability and other benefits of the corporate form of organization

1-15

Problems

Maturity (yrs) 1 2 3 4 5 10 20

2-1 9.20% 8.40% 7.60% 7.30% 7.20% 6.60% 6.30%

2-2 4.90% 5.10% 5.10% 5.20% 5.20% 5.60% 6.00%

2-3 6.10% 6.70% 7.60% 7.40% 7.30% 7.40% 8.20%


								
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