CHAPTER FIVE
TAXES
1
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
3
CORPORATE TAX RATES
• MARGINAL TAX RATES
– are the rates on the next dollar earned
4
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
5
CORPORATE TAX RATES
• CALCULATING AVERAGE TAX RATE:
TOTAL TAX PAID
TOTAL TAXABLE INCOME
6
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
8
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
9
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
10
PERSONAL INCOME TAXES
• TAX-EXEMPT BONDS
– DEFINITION: securities whose income is not
subject to federal income taxes
11
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
12
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
14
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
15
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
– 12 to 18 months
ordinary income
max rate = 28%
16
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
– 12 to 18 months
– more than 18 months
ordinary income
max rate = 28%
20%*
17
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
– 12 to 18 months
– more than 18 months
ordinary income
max rate = 28%
20%*
* unless taxpayer is in the 15% tax
bracket in
which case the rate = 10%
18
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
12 to 18 months
more than 18 months
five years or more
ordinary income
max rate = 28%
20%*
18%**
19
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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