Question

Mr. T is considering a strategy to defer $10,000 income for five years with no significant opportunity cost. Discuss the strategic implications of the following independent assumptions:
a. Mr. T is age 24. He graduated from law school last month and accepted a position with a prominent firm of attorneys.
b. Mr. T is age 63. He plans to retire from business at the end of this year and devote his time to volunteer work and sailing. Short Answer

Answer 1

Answer:

a) Mr. T's the tax savings from the deferral is going to be reduced or even completely eliminated by his additional tax cost in 5 years.

b) Mr. T's the deferral will only be increased by his additional tax savings in 5 years.

Explanation:

First we understand what Marginal Tax Rate is

The marginal tax rate of a person represents that rate of tax incurred as a result of increase in dollar usually measured as increase in tax as a result of an additional dollar of income.

This means that if Mr. T's income increases in 5 years, his marginal tax rate will increase and this will affect his decision as follows

a) Age 24 and just got a job. The implication is that his marginal tax rate in 5 years as an attorney will be higher than his rate as a student, hence, the tax savings from the deferral is going to be reduced or even completely eliminated by his additional tax cost in 5 years.

b) Age, 63 and to be retired. The first implication is that his income in 5 years will be lower than his current income as an employee, hence his marginal tax rate in 5 years will be lower than his current marginal tax rate, hence the deferral will only be increased by his additional tax savings.