It is important to not only know and understand various tax laws, but it is necessary to ascertain how they apply in real life decision-making situation. The following Discussion allows you to apply your knowledge of these tax exclusions.

George, a wealthy investor, is uncertain whether he should invest in taxable or tax-exempt bonds. What tax and nontax factors should be considered?

George needs assistance understanding the different application of prepaid income under tax law and financial accounting. Explain this difference to George.

Please respons # 1 to 3 posted below.

1. From: Rebecca Willis posted May 5, 2018 2:02 AM

1. Tax and non tax items for George to consider:

Tax: Tax exempt bonds are just that. they are tax exempt from local and state taxes, however are not exempt from federal taxes. Even though the tax rate is lower, it serves the public with the earned interest such as school and public services. Taxable bonds do not benefit the public and are taxable by local and state taxes.

Rate of return: tax exempt bonds offer a lower rate of return where taxable bonds yield a higher rate.

Net taxable income: there is the possibility that you could make more money even earning a lower yield with a tax exempt bond than with a taxable bond.

2. Under financial accounting, the GAAP recommendations are for income to be recorded in the period it is earned not payment received. This is called accrual accounting. Prepaid income means that the income will extend to the next taxable year and the money is taxable upon receipt.

2. From: Shaun White posted May 5, 2018 10:32 PM

Tax-exempt bonds are exempt from regular income tax, but are subject to an alternative tax rate. The tax rate is subject to change. On taxable bonds, the bonds are subject to all regular taxes but on the plus side, they offer a higher interest yield than tax-exempt bonds.

Under Financial Accounting, income isn’t counted as income until it is earned. So, if a company is hired and prepaid to complete a project in 6 months, at the end of that project is when the income would count and be taxed. However, under the tax law, any money received at any time is counted as income and subject to the taxes of that period. As another example, a company could get prepaid on day 1 for a 6-month project and the taxes would be imposed as is on that day.

3. From: Latosha Graham posted May 2, 2018 10:24 AM

If George invests in tax-exempt bonds he will get a small return and that is small in the time value of money of the years of the bond. Taxable bonds have a higher yield but also higher risk. He could lose the investment if the company should default with a taxable bond. Tax-exempt bonds are only issued by the government.

When reporting taxes, you must use accrual accounting or cash accounting methods in your business and report as of the method used. You have to inform the IRS which method you use when you report income. When using accrual accounting, you are considered accounts receivable to have the income on your books. You would report your accounts receivable, minus bad debt as income. In cash accounting you would consider income as when you are actually paid, as in cash or credit card payment. Goods paid for but not delivered would be an inventory accounting issue and has nothing to do with simple prepaid and tax laws. You must indicate which inventory method is used to the tax liability, FIFO or LIFO.