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

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.