Government G levies an income tax with the following rate structure: Percentage Rate Bracket 6 % Income from –0– to $30,000 10 Income from $30,001 to $70,000 20 Income from $70,001 to $200,000 28 Income in excess of $200,000 Taxpayer O earns $50,000 annually during years 1 through 10. Taxpayer P earns $20,000 annually during years 1 through 5 and $80,000 annually during years 6 through 10. Assume the tax rate bracket has not changed. Required: How much total income does each taxpayer earn over the 10-year period? Compute each taxpayer’s average tax rate for the 10-year period.

1. Taxpayer O earns $450,000 after-tax income over the 10-year period.

Taxpayer P earns $414,000 after-tax income over the same period.

2. Taxpayer O's average tax rate for the 10-year period = 10%

Taxpayer P's average tax rate for the 10-year period is 17.2%

Explanation:

a) Data:

Percentage Rate Bracket

 6%   Income from –0– to $30,000

10      Income from $30,001 to $70,000

20     Income from $70,001 to $200,000

28     Income in excess of $200,000

b) Taxpayer O:

Annual earnings = $50,000 from year 1 to year 10

Total income = $500,000 ($50,000 * 10)

Tax bracket = 10%

After-tax income = $500,000 * 90% ( 100 - 10%)

= $450,000

Total Tax Liability = $50,000 ($500,000 * 10%)

Average tax rate = 10%

c) Taxpayer P:

Annual earnings = $20,000 from year 1 to year 5

and $80,000 from year 6 to year 10

Total earnings = ($20,000 * 5) + ($80,000 * 5)

= $500,000

After-tax income for 5 years = $100,000 * 0.94 (1 = 0-06)

= $94,000

After-tax income for another 5 years = $400,000 * 0.80 (1 - 0.2)

= $320,000

Total = $414,000

Total tax liability = $86,000 ($500,000 - 414,000)

Average tax rate = $86,000/$500,000 * 100 = 17.2%

the third answer is correct.