FUNDAMENTALS OF INCOME TAX
CHAPTER 1 AND 3 ACTUAL EXAM
2026
QUESTIONHugh has the choice between investing in a City of Heflin bond at 6 percent or
investing in a Surething Incorporated bond at 9 percent. Assuming that both bonds have the
same nontax characteristics and that Hugh has a 40 percent marginal tax rate, what interest rate
does Surething Incorporated need to offer to make Hugh indifferent between investing in the
two bonds? - answer-10%
Reason:
To be indifferent between investing in the two bonds, the Surething Incorporated bond should
provide Hugh the same after-tax rate of return as the City of Heflin bond (6 percent). To solve
for the required pretax rate of return we can use the following formula: After-tax return = Pretax
return × (1 - Marginal Tax Rate).
Surething Incorporated needs to offer a 10 percent interest rate to generate a 6 percent after-
tax return and make Hugh indifferent between investing in the two bonds - i.e.,
6% = Pretax return × (1 − 40%);
Pretax return = 6% ÷ (1 − 40%) = 10%
Scot and Vidia, married taxpayers, earn $240,000 in taxable income and $5,000 in interest from
an investment in City of Tampa bonds. Using the U.S. tax rate schedule for married filing jointly,
how much federal tax will they owe? What is their average tax rate? What is their effective tax
rate? What is their current marginal tax rate? - answer-Scot and Vidia will owe $43,685 in
federal income tax this year computed as follows:
$43,685 = $34,337 + 24% ($240,000 − $201,050).
Scot and Vidia's average tax rate is 18.20 percent.
, Average tax rate = Total tax ÷ Taxable income = $43,685 ÷ $240,000 = 18.20%
Scot and Vidia's effective tax rate is 17.83 percent.
Effective tax rate = Total tax ÷ Total income = $43,685 ÷ ($240,000 + $5,000) = 17.83%
Scot and Vidia are currently in the 24 percent tax rate bracket. Their marginal tax rate on
increases in income up to $143,900, and deductions up to $38,950 is 24 percent.
QUESTIONScot and Vidia, married taxpayers, earn $240,000 in taxable income and $5,000 in
interest from an investment in City of Tampa bonds. (Use the U.S. tax rate schedule for married
filing jointly.)
a.If Scot and Vidia earn an additional $80,000 of taxable income, what is their marginal tax rate
on this income?
b. What is their marginal tax rate if, instead, they report an additional $80,000 in deductions? -
answer-a. If Scot and Vidia earn an additional $80,000 of taxable income, their marginal tax rate
on the income is 24.00 percent.
Marginal tax rate = Change in tax ÷ Change in taxable income = ($62,885 − $43,685) ÷ ($320,000
− $240,000) = 24.00%
Where $62,885 for the revised tax is computed as follows: $62,885 = $34,337 + 24% ($320,000
− $201,050).
b. If Scot and Vidia instead had $80,000 of additional tax deductions, their marginal tax rate on
the deductions would be 22.97 percent.
Marginal tax rate = Change in tax ÷ Change in taxable income = ($25,306 − $43,685) ÷ ($160,000
− $240,000) = 22.97%
Where $25,306 for the revised tax is computed as follows: $25,306 = $10,852 + 22% ($160,000
− $94,300).
QUESTIONMelinda invests $200,000 in a City of Heflin bond that pays 6 percent interest.
Alternatively, Melinda could have invested the $200,000 in a bond recently issued by Surething
Incorporated that pays 8 percent interest and has risk and other nontax characteristics similar to
the City of Heflin bond. Assume Melinda's marginal tax rate is 25 percent.
CHAPTER 1 AND 3 ACTUAL EXAM
2026
QUESTIONHugh has the choice between investing in a City of Heflin bond at 6 percent or
investing in a Surething Incorporated bond at 9 percent. Assuming that both bonds have the
same nontax characteristics and that Hugh has a 40 percent marginal tax rate, what interest rate
does Surething Incorporated need to offer to make Hugh indifferent between investing in the
two bonds? - answer-10%
Reason:
To be indifferent between investing in the two bonds, the Surething Incorporated bond should
provide Hugh the same after-tax rate of return as the City of Heflin bond (6 percent). To solve
for the required pretax rate of return we can use the following formula: After-tax return = Pretax
return × (1 - Marginal Tax Rate).
Surething Incorporated needs to offer a 10 percent interest rate to generate a 6 percent after-
tax return and make Hugh indifferent between investing in the two bonds - i.e.,
6% = Pretax return × (1 − 40%);
Pretax return = 6% ÷ (1 − 40%) = 10%
Scot and Vidia, married taxpayers, earn $240,000 in taxable income and $5,000 in interest from
an investment in City of Tampa bonds. Using the U.S. tax rate schedule for married filing jointly,
how much federal tax will they owe? What is their average tax rate? What is their effective tax
rate? What is their current marginal tax rate? - answer-Scot and Vidia will owe $43,685 in
federal income tax this year computed as follows:
$43,685 = $34,337 + 24% ($240,000 − $201,050).
Scot and Vidia's average tax rate is 18.20 percent.
, Average tax rate = Total tax ÷ Taxable income = $43,685 ÷ $240,000 = 18.20%
Scot and Vidia's effective tax rate is 17.83 percent.
Effective tax rate = Total tax ÷ Total income = $43,685 ÷ ($240,000 + $5,000) = 17.83%
Scot and Vidia are currently in the 24 percent tax rate bracket. Their marginal tax rate on
increases in income up to $143,900, and deductions up to $38,950 is 24 percent.
QUESTIONScot and Vidia, married taxpayers, earn $240,000 in taxable income and $5,000 in
interest from an investment in City of Tampa bonds. (Use the U.S. tax rate schedule for married
filing jointly.)
a.If Scot and Vidia earn an additional $80,000 of taxable income, what is their marginal tax rate
on this income?
b. What is their marginal tax rate if, instead, they report an additional $80,000 in deductions? -
answer-a. If Scot and Vidia earn an additional $80,000 of taxable income, their marginal tax rate
on the income is 24.00 percent.
Marginal tax rate = Change in tax ÷ Change in taxable income = ($62,885 − $43,685) ÷ ($320,000
− $240,000) = 24.00%
Where $62,885 for the revised tax is computed as follows: $62,885 = $34,337 + 24% ($320,000
− $201,050).
b. If Scot and Vidia instead had $80,000 of additional tax deductions, their marginal tax rate on
the deductions would be 22.97 percent.
Marginal tax rate = Change in tax ÷ Change in taxable income = ($25,306 − $43,685) ÷ ($160,000
− $240,000) = 22.97%
Where $25,306 for the revised tax is computed as follows: $25,306 = $10,852 + 22% ($160,000
− $94,300).
QUESTIONMelinda invests $200,000 in a City of Heflin bond that pays 6 percent interest.
Alternatively, Melinda could have invested the $200,000 in a bond recently issued by Surething
Incorporated that pays 8 percent interest and has risk and other nontax characteristics similar to
the City of Heflin bond. Assume Melinda's marginal tax rate is 25 percent.
