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Created by:
danchinaman on March 18, 2012
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Description:
Taxes and Private Wealth Management in a Global Context
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17 terms
Terms | Definitions |
|---|---|
 Types of taxes | Ordinary income taxes: - flat or progressive Investment income tax: may be favorable - interest income - Dividends - Capital gains |
| Calculating Taxes Due | Progressive income tax system Plus = addition of al previous taxes |
| Different tax regimes | ... |
| Accrual taxation | paid periodically (annually) tax drag structure PF to avoid accrual taxation |
| Tax drag | is the reduction in return caused by the payment of any type of taxes - tax drag dollar = amount of total gain lost to taxes - tax drag % = % of total gain lost to taxes - tax drag % > tax rate - both increase with loner holding periods and return rate |
| Capital gains taxes | - CAN BE AVOIDED - taxes paid on the gain (long or short pos) when an asset is sold or purchased - CG = difference purchase and selling price = tax basis - LT CGs are often taxed at a reduced rate - CGs can be timed to delay payment of taxes - "HArvest" capital losses to offset capital gains and reduce taxes COST BASIS??? as basis falls, tax drag increases |
| Wealth Taxes | tax on the entire value of assets held - principal + earnings - assumes beg 1000 balance has already been taxed - same effect as accrual tax (?) - but lower return increases diminishment (?) |
| Accrual Equivalent Returns | RAE - Effective (after-tax) geometric return - after less than the annual taxble (berfore-tax) return - difference between the two is determined by the investment horizon and the proportion of the total gain that is deferred - The greater the proportion of return that is deferred, the greater the value of the tax deferral - time horizon up, value up. - accrual equivalent tax rate TAE -- tax rate that makes pre-tax return equal to RAE |
| Summary of relationships | - accrual taxes (> 1 year) : tax drag % > tax rate -- inv horizon rises, tax drag % and $ rises -- inv return rises, tax drag % and $ rises - Deferred CG taxes, B=1, Tax Drag % = tax rate - Deferred CG taxes, B<1, Tax Drag % > tax rate -- as B% falls -> tax drag % and tax drag $ rise --- inv horizon rises -> tax drag unchanged, value of tax deferral increases --- inv return rises -> tax drag unchanged, value of tax deferral increases -- B% falls -> RAE falls -- B% falls -> TAE rises |
| Account Tax Profiles | Taxable - taxes paid annually Tax-deferred -front-end benefits, PV is before-tax Tax-exempt - back-end benefits, PV is after-tax |
| Tax-exempt or tax-deferred? | tax exempt: taxes are paid at t=0 tax-deferred, taxes are paid at t=N - Ceteris paribus, difference in final "spendable cash" is due to differences in the current tax rate and expected future tax rate taxable income/Tax rate lower today -> use tax-exempt taxable income/tax rate in the future -> use tax-deferred |
| Taxes and investment risk | in a taxble accont, governemnt shares both gains and losses - taxes actually reduce the range of returns from the investor's perspective - reduced standard deviation!! |
| Trading behavior, taxes and returns | Tax alpha - extra inv value created by effective tax management - any amount of taxes not paid remains in the account to earn future (compounded) returns - Low current income (e.g. equities) -> hold in taxable accounts - High current income (e.g. bonds) -> hold in tax protected accounts Four types of investors 1. Traders - all gains ST, few tax benefits 2. Active investor - less churn, some gains taxed at reduced rates 3. Passive investor - Buy and hold, most gains are deferred 4. Exempt investor - no investment taxes |
| Tax Loss Harvesting | Use losses to offset gains Reinvestment caveat - if security is harvested, the selling price of the old security becomes the tax basis for the new security -> tax only deferred! -- only time value benefit!! |
| Highest-in, First-out accounting | HiFo -> maximizes the loss for harvesting or -> minimize the taxable gain |
| Lowest-in, First-out accounting | If tax rates are expected to rise, the investor could choose LIFO - allows to slect the lot with lowest cost absis - maximize realized gains before effective tax rate increases |
| Asset Location and Optimization | When possible: - HOld high return (high income) assets in tax-exempt accounts, e.g. 401K - Hold low return (low income) assets in taxable accounts -> taxable portfolio |
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