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Hank, a calendar-year taxpayer, uses the cash method of accounting for his sole proprietorship. In late December, he performed $20,000 of legal services for a client. Hank typically requires his clients to pay his bills immediately upon receipt. Assume his marginal tax rate is 32 percent this year and will be 35 percent next year, and that he can earn an after-tax rate of return of 12 percent on his investments.

User Skoeb
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Step-by-step explanation:

To analyze the tax implications and financial considerations for Hank, we need to evaluate two scenarios: (1) recognizing the income in the current year and (2) deferring the income to the following year.

Scenario 1: Recognizing the income in the current year

If Hank recognizes the $20,000 of legal service income in the current year, he will be subject to income tax at his marginal tax rate of 32 percent. This means he will owe $6,400 in taxes ($20,000 x 0.32). After paying the tax, he will have $13,600 ($20,000 - $6,400) available for investment.

Scenario 2: Deferring the income to the following year

If Hank chooses to defer the income to the following year, he won't have to pay tax on it in the current year. He can invest the full $20,000 and earn an after-tax rate of return of 12 percent. This will result in an investment return of $2,400 ($20,000 x 0.12).

Comparing the two scenarios, we can calculate the net benefit of deferring the income. The net benefit is the difference between the investment return in Scenario 2 and the taxes owed in Scenario 1. In this case, the net benefit is $2,400 - $6,400 = -$4,000.

Since the net benefit is negative, it would be financially disadvantageous for Hank to defer the income to the following year. Recognizing the income in the current year and paying the taxes allows him to invest the remaining amount immediately and potentially earn a higher after-tax return.

However, it's important to note that tax and investment decisions depend on various factors, and this analysis is based on the provided information. Consulting with a tax professional or financial advisor would be recommended for a comprehensive evaluation of Hank's specific situation.

User Conan
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