4 areas taxation resides
Accounting, Laws, Economics and Finance, and Ethics
During the 1970's how high did the US Marginal Tax rate get?
70% in 1975
3 components of SW Framework
A set of algebraic equations, subjective and other factors not included in the equations, and descriptions of rules and concepts
3 major components of the Federal Budget Expenditures
Social Security/Unemployment (33%)
Medicine/Healthcare (27%)
Military (16%)
How big of a deficit did the Federal Gov't budget for 2015?
600 Billion
Definition of efficient tax planning
The process of identifying tax strategies that maximize after-tax profitability in a legal and ethical manner
3 ways to measure after-tax profitability
FV of After-tax cash flows
Present value of After-tax cash flows
Internal Rate of Return of After-tax cash flows
3 parties involved in taxes
Buyer
Seller
Tax Collector
Items excluded from Taxable income
Interest from municipal bonds, federal taxes
SW Framework themes
All parties, All tax costs, and All nontax costs and benefits
"Implicit taxes in dollars"
Taxes paid indirectly in the form of lower BTCF on tax-favored investments
ATCF Shortcut
Change in BTCF x (1 - t) when the change in TI = the change in BTCF
Marginal investor
Investor who is indifferent between alternative investments
Adjusted basis
The same as book value
Realized gain/loss
The accounting gain or loss (difference between sale price and adjusted basis) - not always affecting tax liability
Recognized gain/loss
The amount of gain or loss that appears on the tax return - increase or decrease tax liability
How are federal income taxes treated on the tax return?
Not deductible
Why does depreciation fluctuate between income statements and tax returns?
Straight-line depreciation is used for book purposes where accelerated depreciation is used for tax purposes
Average Tax Rate
Tax / Taxable Income
4 steps to SW problem solving framework
Identify all alternatives
Evaluate each
Select optimal alternative based on evaluation
Monitor and modify the plan if necessary
How the do the rankings of calculating FV vs. r compare?
Will always be the same
When is the tax character determined?
Immediately after the transaction and before any netting takes place
6 types of tax characters
Ordinary income/loss
Short-term capital gain/loss
Long-term capital gain/loss
Taxable interest income
Dividend income
Itemized deductions
What rate are LTCG/L taxed at?
g (not t)
What rate is dividend income taxed at?
g (not t)
Two types of capital assets
Investment assets
Personal Assets
Investment asset
Asset expected to rise in value held by an individual or a business - depends on the motive of who is holding
What assets are not included in the investment asset category?
Inventory and assets utilized in an active trade or business
Personal Assets
Not used for business or investments
When an investment assets realizes a gain or loss, what should you do?
Recognize it and tax at g (shield if loss)
When a personal asset realizes a gain what should you do? What about for a loss?
Recognize the gain and tax at g
Do not recognize the loss
When inventory realizes a gain or loss, what should you so?
Recognize it and tax at t (shield if loss)
How should corporations deal with multipole capital gains and losses?
Net them all together
Net capital gain is taxed as ordinary income (t)
How far back are Net capital losses carried back and forward?
Carry back 3 years
Carry forward 5 years
How are net capital gains treated?
Taxed as ordinary income in the current year
What should be done with a Negative Taxable income?
Treat as a Net Operating Loss and carry back 2 years and/or carry forward 20 years
Adjusted Gross Income
A subtotal of all income earned during a year
What is the relationship between g and t
g is always less than t
How high do ordinary deductions on all capital loss go up to?
$3,000
How do individuals carry over capital losses?
Carry forward for as long as needed
What tax rate is applied to LTCL and STCL for the tax shield?
Either g or t depending on the netting process
Relative advantage of Raw Land
Taxed at g, deferral
Relative advantage of SPDA
Deferral
Relative advantage of Mutual fund
Taxed at g
With respect to g, how do Mutual funds and SPDAs compare?
If g>0
At shorter n, mutual fund r > SPDA r
At longer n, SPDA r > Mutual fund r
What are the implications if g=0?
Mutual fund r > SPDA r
Raw land r = R
With what type of dollars are deductible pension fund deposits made?
Before-tax dollars
With a constant t, what happens to the r of deductible pension funds?
remains the same
With a declining marginal tax rate, what happends to the r of deductible pension funds?
r>R
r falls as the period increases, but remains greater than R
With a rising marginal tax rate, what happends to the r of deductible pension funds?
r<R
As n increases, r increases but remains smaller than R
Ranking of savings vehicle r's
Lowest - Savings Account
MF and SPDA depend on n
Next highest - Raw Land
Highest - Roth IRA
Characteristics of savings accounts
Initial investment is not deductible, annual taxation, tax rate is ordinary (t not g)
Characteristics of mutual funds
Initial investment is not deductible, annual taxation, tax rate is capital gains (g)
Characteristics of raw land
Initial investment is not deductible, Deferred taxation, tax rate is capital gains (g)
Characteristics of Single Preferred Deferred Annuity
Initial investment is not deductible, Deferred taxation, tax rate is ordinary (t)
Characteristics of Deductible Pension (401k)
Initial investment IS deductible, Deferred taxation, tax rate is ordinary (t)
How do capital gains and losses affect taxable income?
They do not, they are taxed separately
