Assignment 1, Question 8: Interest versus dividend income During the year just e
ID: 2801153 • Letter: A
Question
Assignment 1, Question 8:
Interest versus dividend income
During the year just ended, Shering Distributors, Inc., had pretax earnings from operations of $496,000. In addition, during the year it received $28,000 in income from interest on bonds it held in Zig Manufacturing and received $28,000 in income from dividends on its 6% common stock holding in Tank Industries, Inc. Shering is in the 40% tax bracket and is eligible for a 70% dividend exclusion on its Tank Industries stock.
a. Calculate the firm's tax on its operating earnings only.
b. Find the tax and the after-tax amount attributable to the interest income from Zig Manufacturing bonds.
c. Find the tax and the after-tax amount attributable to the dividend income from the Tank Industries, Inc., common stock.
d. Compare, contrast, and discuss the after-tax amounts resulting from the interest income and dividend income calculated in parts b. and c.
e. What is the firm's total tax liability for the year?
Explanation / Answer
a)
Firm's tax on operating Income
= pretax earnings from operations * tax rate = 496,000 * 0.4 = 198400
b)
Tax and after tax amount due to the income from Zig manufacturing bonds
c)
Tax and after tax amount due to the income from Tank Industries common stock
d)
Here the after tax amount(dividend) from the stock investment is 24,640 and the after tax amount(interest) from the bond investment 16,800.
Hence it is obvious that stock investment in the Tank industries is more profitable and in turn it attracts more investment.
This is mainly due the 70% dividend exclusion on the tax bracket.
Before tax Income 28,000 deductions (0) Taxable amount 28,000 at 40% tax rate, tax amount 11,200 After tax income(Before tax Income - tax amount) 16,800