Nick and Jolene are married. Nick is 61 and retired in 2014 from his job with Amalgamated Company. Jolene is 56 and works part-time as a special education teacher. Nick and Jolene have a substantial amount of investment savings and would like to reorganize it to achieve the best after-tax return on their investments. They give you the following list of projected cash receipts for 2015:

Jolene’s salary $14,000

Nick’s pension—fully taxable 12,500

Interest income 4,000

Dividend income 2,500

Social Security benefits 7,000

Farmer’s Fund annuity 6,000

In addition, Nick tells you that he owns a duplex that he rents out. The duplex rents for 2015 are $18,000, and Nick estimates expenses of $22,000 related to the duplex. The annuity was purchased 18 years ago for $20,000, and pays $500 per month for 10 years.

Nick and Jolene’s investments consist of the following:

6-month certificates of deposit (CDs) $100,000

1,000 shares of Lardee’s common stock (current market value = $7 per share, projected 2015 dividend = $1 per share)—cost 10,000

2,000 shares of Corb Company common stock (current market value = $20 per share, projected 2015 dividend = $.75 per share)—cost 20,000

1. Assuming that Nick and Jolene have total allowable itemized deductions of $13,350 in 2015 and that they have no dependents, determine their 2015 taxable income and tax liability based on the projections they gave you.

For the 2015 tax year, Nick and Jolene’s taxable income equals $15,400. The amount due on $15,400 for the 2015 tax year would be $1474.00

1. The 6-month CDs consist of two $50,000 certificates, both of which yield 4% interest. One CD matures on January 3, 2015. Nick’s banker tells him that he can renew the CD for one year at 4%. Nick’s stockbroker tells him that he can purchase tax-exempt bonds with a yield of 3%. Nick would like you to determine whether the tax-exempt bonds provide him a better after-tax return than the CD.

Since the CD interest is remaining the same there will be no changes in the AGI from this investment. The after-tax return on the CD will equal $1,800 which is determine by the total amount of the two CDs at $50,000 multiplied by the 4% interest equaling $2000 which is then multiplied by (1 -10%)

The interest earned on the tax-exempt portion of the bond total $1500

($50,000 x 3%). Since the interest on this is tax-exempt the AGI will be lower resulting in an overall decrease of the portion taxed on social security benefits resulting in a savings of $25.00. The overall return on the tax bond will be $1525.00 (1500 plus 25)

AGI without Social Security benefit:

Previous adjusted gross income $ 34,750

Less: Interest income on CD (2,000)

Previous Social Security (1,750)

AGI without Social Security $ 31,000

Taxable portion of Social Security:

1/2 x ($31,000 + $3,500 + $1,500 - $33,000) $ 1,500

Previous Social Security 1,750

Reduction in taxable income $ 250

Marginal tax rate x 10%

Additional tax savings $ 25

Investment into the 4% CD yields and additional $275 after-tax over the tax-exempt bond however, does not impact the overall income of Nick and Jolene.

1. Jolene is concerned that they are not getting the best return on their Corb Company stock. When they purchased the stock in 2004, the $.75 per share dividend was yielding 10% before taxes. However, the rise in market value has far outpaced the dividend growth, and it is yielding only 3.75%, based on the current market value. Jolene thinks they should sell the stock and purchase either the 3% tax-exempt securities or the 4% CD if it would be a better deal from an income tax viewpoint. Calculate the tax effect on their 2015 income of selling the shares, and determine whether they should sell the shares and invest the after-tax proceeds in tax-exempt securities or the 4% CD. Do this calculation after you have determined the best option regarding the CD that matures in January.

The impact of the sale in stock will result in an overall gain of $20,000 and is considered to be a long-term capital gain that will be taxed at 0% (marginal rate is 10%). The increase of income also results in additional Social Security that is subject to tax $4,200 ($5,950 maximum - $1,750 taxable portion without the sale) and decrease by the $1,500 (2,000 x $.75) of dividends on unsold stock. This results in a taxable income of $36,700, a tax liability of $1,570 and an increase in tax of $420 from the sale:

Amount realized from sale (2,000 x $20) $ 40,000

Basis of stock 20,000

Total gain on sale $ 20,000

Increase in taxable portion of Social Security 4,200

Dividend income not received (1,500)

Increase in taxable income $ 22,700

Previous taxable income 15,400

Taxable income with sale $ 38,100

Tax on $15,700: $15,700 x 10% $ 1,570

Tax on $1,000 other dividends: $1,000 x 0% -0-

Tax on $20,000 capital gain: $20,000 x 0% -0-

Total tax with sale $ 1,570

Minus: Tax without sale 1,150

Tax attributable to sale $ 420

Amount available to reinvest = $40,000 - $420 $ 39,580

Increase in taxable portion calculation:

The sale of the stock will increase Nick and Jolene's modified adjusted gross income to $58,100 ($38,100 + $20,000). Because this is greater than $44,000, they are subject to the 2nd tier inclusion rule. This results in the maximum amount of Social Security benefits being included in gross income, $5,950 (85% x $7,000):

Social Security subject to tax under the 50% rule:

The lesser of :

1. .5 x ($7,000) = $3,500

or

2. .5 x ($36,500 + $20,000 - $33,000) = $11,750

The amount included under the 2nd tier inclusion rule is $5,950:

The lesser of:

85% x $7,000 which is $5,950

or the sum of 85% x ($55,500 - $44,000) which is $9,775

and the smaller of $3,500 and $6000 (9775 plus 3500) equals 13,275

Due to the sale of the stock driving up the Social Security to its maximum, the returns on the CD as well as the tax-exempt bonds will be calculated based on marginal tax rates.

CD - $39,580 x 4% = $1,583 x (1 - 10%) = $1,425

Tax-Exempt Bond - $39,580 x 3% = $1,187

The current return after-tax on the $1,500 of stock dividends is $1,500

Dividends - $2,000 x $.75 = $1,500 x (1 - 0%) = $1,500

Due to the 0% tax rate on dividends, the stock provides the highest after tax return.