CHAPTER FIVE

TAXES

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 TAXES IN THE U.S.

• CORPORATE TAXES
– forms of business are taxed differently
• single proprietor and partnership income is taxed at
personal income rates
• corporate income may be taxed twice
– once as it is earned using the corporate income rates
– again as dividend income using the personal rates

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 CORPORATE TAX RATES

• MARGINAL TAX RATES

– are the most important for the corporation and
represent the tax on additional income earned

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 CORPORATE TAX RATES

• MARGINAL TAX RATES

– are the rates on the next dollar earned

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 CORPORATE TAX RATES

• MARGINAL TAX RATES: An Example

Suppose a corporation earns $85,000
It pays
.15 on first $50,000 = $7,500
.25 on next $25,000 = $6,250
.34 on next $10,000 = $3,400
Total tax on$85,000= $17,150
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 CORPORATE TAX RATES

• CALCULATING AVERAGE TAX RATE:

TOTAL TAX PAID

TOTAL TAXABLE INCOME

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 CORPORATE TAX RATES

• CALCULATING AVERAGE TAX RATE

An Example

$17,150 / $85,000 = 20.18%

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 PERSONAL INCOME TAXES

• CALCULATING AFTER-TAX INCOME

GROSS INCOME
- ADJUSTMENTS
ADJUSTED GROSS INCOME
- DEDUCTIONS
TAXABLE INCOME
- TAXES
AFTER-TAX INCOME

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 PERSONAL INCOME TAXES

• EXAMPLE: A MARRIED COUPLE IS

EVALUATING AN INVESTMENT
Assume: No Bracket “Creep”
Taxable Income = $80,000
Marginal Tax rate = .28
Possible Investment Income:
Tax (.28 x $3,000) = $840

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 PERSONAL INCOME TAXES

• EXAMPLE: A MARRIED COUPLE ARE

EVALUATING AN INVESTMENT
Assume: Bracket “Creep”
Possible Investment Income: $20,000
Tax .28 x 16,900 = $4,732
.31 x 3,100 = $ 961
20,000 = $5,693

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 PERSONAL INCOME TAXES

• TAX-EXEMPT BONDS
– DEFINITION: securities whose income is not
subject to federal income taxes

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 PERSONAL INCOME TAXES

• TAX-EXEMPT BONDS
– most income from bonds issued by states,
municipalities, and their agencies need not be
included in taxable income for federal returns

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 PERSONAL INCOME TAXES

• TAX-EXEMPT BONDS
– to calculate fully-taxable-equivalent yield of a
tax-exempt bond use the formula

i
yield =
1 t
where t = the investor’s marginal tax rate
i = the tax-exempt yield

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TAX TREATMENT FOR CAPITAL GAINS
AND LOSSES

• CATEGORIES OF GAIN
– depend on holding periods and tax treatment
HOLDING PERIOD TAX TREATMENT

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TAX TREATMENT FOR CAPITAL GAINS
AND LOSSES

• CATEGORIES OF GAIN
– depend on holding periods and tax treatment
HOLDING PERIOD TAX TREATMENT
– Less than one year ordinary income

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TAX TREATMENT FOR CAPITAL GAINS
AND LOSSES

• CATEGORIES OF GAIN
– depend on holding periods and tax treatment
HOLDING PERIOD TAX TREATMENT
– Less than one year ordinary income
– 12 to 18 months max rate = 28%

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TAX TREATMENT FOR CAPITAL GAINS
AND LOSSES

• CATEGORIES OF GAIN
– depend on holding periods and tax treatment
HOLDING PERIOD TAX TREATMENT
– Less than one year ordinary income
– 12 to 18 months max rate = 28%
– more than 18 months 20%*

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TAX TREATMENT FOR CAPITAL GAINS
AND LOSSES

• CATEGORIES OF GAIN
– depend on holding periods and tax treatment
HOLDING PERIOD TAX TREATMENT
– Less than one year ordinary income
– 12 to 18 months max rate = 28%
– more than 18 months 20%*
* unless taxpayer is in the 15% tax bracket in
which case the rate = 10%
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TAX TREATMENT FOR CAPITAL GAINS
AND LOSSES

• CATEGORIES OF GAIN
– depend on holding periods and tax treatment
HOLDING PERIOD TAX TREATMENT
– Less than one year ordinary income
– 12 to 18 months max rate = 28%
– more than 18 months 20%*
– five years or more 18%**

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TAX TREATMENT FOR CAPITAL GAINS
AND LOSSES

• CATEGORIES OF GAIN (more than 5 years)

– depend on holding periods and tax treatment
HOLDING PERIOD TAX TREATMENT
– five years or more 18%**
** Exception: If taxpayer is in 15% tax
bracket, the asset must have been sold in the
year 2001 or later, then rate = 8%

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