Which of the following will tend to diminish the benefit of the interest tax shield given a progressive tax rate structure?
I.a reduction in tax rates
II.a large tax loss carryforward
III.a large depreciation tax deduction
IV.a sizeable increase in taxable income
A)I and II only
B)I and III only
C)II and III only
D)I, II, and III only
E)I, II, III, and IV

Question

Quizplus · Accepted Answer

The interest tax shield is the reduction in taxes that results from deducting interest expenses from taxable income. A progressive tax rate structure means that the tax rate increases with income, so higher-income taxpayers pay a higher percentage of their income in taxes.

I. A reduction in tax rates would decrease the benefit of the interest tax shield for all taxpayers, regardless of their income level.

II. A large tax loss carryforward would not necessarily diminish the benefit of the interest tax shield, as it would only apply when the taxpayer has net operating losses in future years.

III. A large depreciation tax deduction would also decrease taxable income, thereby increasing the benefit of the interest tax shield, particularly for high-income taxpayers who face higher tax rates.

IV. A sizeable increase in taxable income would reduce the benefit of the interest tax shield, particularly for high-income taxpayers who face higher tax rates.

Therefore, choices I, II, and III are incorrect, and the correct answer is choice D, as all three factors, I, II, and IV, could diminish the benefit of the interest tax shield.

Which of the Following Will Tend to Diminish the Benefit