Final answer:
A taxpayer may accept a reduced before-tax rate of return on a tax-favored asset, resulting in a lower tax liability on the investment.
Step-by-step explanation:
When a taxpayer accepts a reduced before-tax rate of return on a tax-favored asset, they are essentially accepting a lower return on their investment in exchange for certain tax benefits. As a result, the taxpayer will have a lower tax liability on the investment. This means that they will have a reduced tax burden on the income generated from the investment compared to if they had chosen a non-tax-favored asset.
For example, let's say a taxpayer has the option to invest in a tax-favored municipal bond that offers a before-tax rate of return of 3%. They could potentially accept this lower rate of return because the interest income earned from municipal bonds is typically exempt from federal income tax. As a result, they would not have to pay any taxes on the interest income earned from this investment, which would lower their overall tax liability.