Archive for the ‘Capital gains – taxes’ Category

Financial math: Capital gains tax rates are going up 8.8% … So, how much will after-tax capital gains go down?

January 8, 2013

This is a relatively simple financial math question that most people I’ve asked have gotten wrong.

Answers have ranged from less than 8.8% – since only capital gains are being taxed (huh?) … 8.8% – because that’s how much the marginal rate is going up … to more than 8.8% – “otherwise you wouldn’t be asking the question”.

First, what’s magic about 8.8%?

Well, Obama did what he promised and jacked capital gains tax rates from 15% to 20% … and, don’t forget ObamaCare has a 3.8% non-payroll payroll tax on investment income starting in 2013.

So,  the effective capital gains tax rate is going from 15% to 23.8% … a delta of 8.8%.

That 8.8% increase will cut after-tax capital gains by 10.35% !

If you don’t believe me, here’s he math …

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HOT Encore: If capital gains tax rates go up 8.8%, how much will after-tax capital gains ROIs go down?

January 5, 2013

Here’s an encore presentation of a HOT: Homa Online Tutorial originally posted before the election.

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Well,  Obama got his dream to come true — capital gains rates have been jacked from 15% to 23.8% ….  the basic capital gains tax rate went  from 15% to 20% … and ObamaCare has a 3.8 non-payroll payroll tax on investment income starting in 2013.

So, the effective capital gains tax rate goes from 15% to 23.8% … a delta of 8.8%.

That 8.8% tax rate increase will cut after-tax capital gains ROIs.

By how much?

Answer: The pre-tax ROI times 8.8%.

Here’s the math …

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Broke: Geithner says so … but, Q4 tax revs are surging … huh?

December 27, 2012

Somebody explain this to me.

Turbo-tax Tim Geithner sent Harry Reid a conveniently timed  letter yesterday, reading in part:

Dear Mr. Leader:

I am writing to inform you that the statutory debt limit will be reached on December 31, 2012, and to notify you that the Treasury Department will shortly begin taking certain extraordinary measures authorized by law to temporarily postpone the date that the United States would otherwise default on its legal obligations.

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OK, the fact that the U.S. is broke and has exhausted its credit line is not new news.

Here  what I don’t understand.

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HOT: If capital gains tax rates go up 8.8%, how much will after-tax capital gains ROIs go down?

October 16, 2012

Here’s another HOT: Homa Online Tutorial …

Well, Obama says he’ll jack capital gains tax rates from 15% to 20% … and ObamaCare has a 3.8 non-payroll payroll tax on investment income starting in 2013.

So, if Obama is elected and he keeps his promise … the effective capital gains tax rate goes from 15% to 23.8% … a delta of 8.8%.

That 8.8% tax rate increase will cut after-tax capital gains ROIs.

By how much?

Answer: The pre-tax ROI times 8.8%.

In other words, the answer depends on the proportion of a stock’s value that is unrealized capital gains.

The answer isn’t intuitive and the math is a bit hairy, so let’s run thru an example ….

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Scenario 1 – CG Tax = 15%

Assume that you bought a stock for $750 and sold it for $1,000 … netting a $250 pre-tax gain.

The pre-tax ROI is 33% … $250 divided by $750.

If the capital gains tax is 15%, you pay $37.50 in taxes … netting you, after taxes, $212.50.

The after-tax ROI is 28.3% … $212.50 divided by $750.

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Scenario 2 – CG Tax = 23.8%

Again assume that you bought a stock for $750 and sold it for $1,000 … netting a $250 pre-tax gain.

The pre-tax ROI is still 33% … $250 divided by $750.

If the capital gains tax is 23.8%, you pay $59.50 in taxes … netting you, after taxes, $190.50.

The after-tax ROI is 25.4% … $190.50 divided by $750.

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The Difference

The CG-ROI @15% is 28.3%, where CG-ROI @ 15% is the Capital Gains ROI at a 15% Tax Rate.

The CG-ROI @23.8% is 25.4%, where CG-ROI @ 23.8% is the Capital Gains ROI at a 23.8% Tax Rate

The difference is 2.9% … that is, the CG-ROI dropped by 2.9 percentage points.

Note that 2.9% is equal to the pre-tax ROI (33%) times the difference in the tax rates (8.8%)

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The generalizable answer

By math magic, the difference in after tax ROIs  are always equal to the pre-tax ROI (which varies depending on the relationship between a stock’s unrealized capital gains and its cost basis) times the difference in the tax rates (in this case, the 8.8% difference between  15% and 23.8%).

If you’re interested, click to view the math work …  if you’re not, skip to the table below.

Here’s a handy look-up table.

UR-CG are unrealized capital gains as a percentage of current stock market value.

In the above example, UR-CG equals 25% … $250 pre-tax capital gains divided by stock’s current market value $1,000 … and there’s a 2.9 percentage point drop in ROI.

As you’d expected, the greater the percentage of capital gains embedded in a stock, the greater the ROI hit if marginal tax rates go up.

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So what?

I don’t give investment advice, but the numbers say that if you expect Obama to be re-elected … and if you expect him to keep his promise and jack up capital gains tax rates … and you have stocks with a high proportion of embedded capital gains … you should probably consider selling.

Technical tax note: Wash sales rules don’t apply to stocks sold at a gain … that is, you can sell them pay the capital gains taxes and immediately buy them back at a stepped-up basis (i.e. the current market price).

In a subsequent post I’ll work thru the math re: whether that makes sense.

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HOT: If capital gains tax rates go up 8.8%, how much will after-tax capital gains go down?

October 15, 2012

Another HOT: Homa Online Tutorial

This is a relatively simple financial math question that most people I’ve asked have gotten wrong.

Answers have ranged from less than 8.8% – since only capital gains are being taxed (huh?) … 8.8% – because that’s how much the marginal rate is going up … to more than 8.8% – “otherwise you wouldn’t be asking the question”.

First, what’s magic about 8.8%?

Well, Obama says he’ll jack capital gains tax  rates from 15% to 20% … and ObamaCare has a 3.8 non-payroll payroll tax on investment income starting in 2013.

So, if Obama is elected and he keeps his promise … the effective capital gains tax rate goes from 15% to 23.8% … a delta of 8.8%.

That 8.8% increase will cut after-tax capital gains by 10.35% !

OK, let’s run thru the math.

click for the Homa Online Tutorial
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Recap

Assume that you bought a stock for $750 and sold it for $1,000 … netting a $250 pre-tax gain.

If the capital gains tax is 15%, you pay $37.50 in taxes … netting you, after taxes, $212.50.

If the capital gains tax is 23.8%, you pay $59.50 in taxes … netting you, after taxes, $190.50.

The difference, is $22 ($212.50 less $190.50 … or simply, 8.8% times $250).

So the percentage drop in after-tax net gains is 10.35% ($22 divided by $212.50)

Note that that percentage stays constant at 10.35% regardless of the size of the gain —  in absolute or relative to proportionate cost basis.

That’s not a coincidence, it’s math.

With a capital gains tax rate of 15%, the after tax gain is simply 1 minus the tax rate times the nominal gain … 1 minus 15% is 85%.

With a capital gains tax rate of 23.8%, the after tax gain is simply 1 minus that tax rate times the nominal gain … 1 minus 23.8% is 76.2%.

The difference is still 8.8%, but the denominator of the change ratio is is 85%, not 100% … and, 8.8% divided by 85% is 10.35%.

Again, that answer is generalizable … not specific to this example.

Q.E.D.

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Advanced Financial Math Question

How much will after-tax ROI go down if capital gains tax rates are increased by 8.8%?

Hint: The math is more complicated than the above example, because the answer depends on the cost basis of the stock relative to its current market value.

I’ll give the answer is a later post.

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Here comes the taxman … BOOM!

October 5, 2012

Great analysis published this week by the non-partisan Tax Policy Center that details the potential impacts if the Bush (and Obama) tax cuts are allowed to expire at the end of the year.

The entire report is worth reading if you’re in the 53% who do pay Federal income taxes … or if you’re at the top earning end of the 47% – since you’ll get banged, too.

According to the TPC, there will be different effects on households at different income levels:

For most households, the two biggest increases would be the expiration of the temporary cut in Social Security taxes and the expiration of the 2001/2003 tax cuts.

  • Households with low incomes would be particularly affected by the expiration of the credits expanded or created by the 2009 stimulus.
  • Households at the highest income levels would be particularly affected by expiration of the 2001/2003 tax cuts that apply to upper income levels and by the new health reform taxes.
  • Upper middle-income households would be particularly affected by the expiration of the AMT patch.
  • In addition to raising average tax rates, the fiscal cliff would substantially raise marginal tax rates.  The average marginal tax rate would increase by about 5 percentage points on wages and salaries, by about 5 percentage points on interest income, by about 7 percentage points on long-term capital gains, and by more than 20 percentage points on qualified dividends.

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Potential Stock Sell-off

One implication of increasing marginal tax rates is that some investors would have an incentive to sell appreciated stocks, bonds, and other assets before the end of the year, if they believe the capital gains rate will go up as scheduled and then remain in place for tax year 2013.

That is exactly what happened following the enactment of the Tax Reform Act of 1986, which increased the top capital gains tax rate from 20 percent to 28 percent.

Capital gains realizations almost doubled in 1986 and then fell back in 1987 as investors rushed to take advantage of the soon-to-expire 20 percent rate.

Similar behavior is likely this year unless investors believe that the scheduled tax increases will be averted.

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In summary: Ouch.

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