Problem:
Assume that a taxpayer can choose when he is to receive $10,000 of fully taxable income. If the taxpayer receives the income at the end of Year 1, he will receive exactly $10,000. If he delays receipt of the income until the end of Year 2, the amount will grow to $11,000. If the taxpayer takes the money at the end of Year 1, he can invest the proceeds and earn a pre- tax return of 10 percent over the next year.
Required:
Question 1: If the taxpayer faces a marginal tax rate of 31 percent in both Year 1 and Year 2, when should he elect to receive the income?
Question 2: At what pre- tax rate of return, will the taxpayer be indifferent to taking the money in Year 1 and Year 2?
Question 3: If the taxpayer's marginal tax rate increases to 35 percent in Year 2, when should he elect to receive the income?
Question 4: What would the tax rate need to be in Year 2 to make the taxpayer indifferent?
Note: Explain all steps comprehensively.