CHAPTER TWELVE TAXES AND
INFLATION
TAXES IN THE U.S.
CORPORATE TAXES
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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
CORPORATE TAX RATES
MARGINAL TAX RATES
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are the most important for the corporation and represent the tax on additional income earnedCORPORATE TAX RATES
MARGINAL TAX RATES
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are the rates on the next dollar earnedCORPORATE 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
CORPORATE TAX RATES
CALCULATING AVERAGE TAX RATE
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the average tax rate =TOTAL TAX PAID
TOTAL TAXABLE INCOME
CORPORATE TAX RATES
CALCULATING AVERAGE TAX RATE
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the average tax rate is equal to the An Example$17,150 / $85,000 = 20.18%
PERSONAL INCOME TAXES
CALCULATING AFTER-TAX INCOME
GROSS INCOME - ADJUSTMENTS
ADJUSTED GROSS INCOME - DEDUCTIONS
TAXABLE INCOME - TAXES
PERSONAL INCOME TAXES
EXAMPLE: A MARRIED COUPLE ARE EVALUATING AN INVESTMENT
Assume: No Bracket “Creep”
Taxable Income = $80,000 Marginal Tax rate = .28
Possible Investment Income:
Tax (.28 x $3,000) = $840
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
PERSONAL INCOME TAXES
TAX-EXEMPT BONDS
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DEFINITION: securities whose income is not subject to federal income taxesPERSONAL INCOME TAXES
TAX-EXEMPT BONDS
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most income from bonds issued by states, municipalities, and their agencies need not be included in taxable income for federal returnsPERSONAL INCOME TAXES
TAX-EXEMPT BONDS
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to calculate fully-taxable-equivalent yield of a tax-exempt bond use the formulayield = __i__
1 - t
where t = the investor’s marginal tax rate i = the tax-exempt yield
TAX TREATMENT FOR CAPITAL GAINS AND LOSSES
CATEGORIES OF GAIN
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depend on holding periods and tax treatmentHOLDING PERIOD TAX TREATMENT
TAX TREATMENT FOR CAPITAL GAINS AND LOSSES
CATEGORIES OF GAIN
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depend on holding periods and tax treatmentHOLDING PERIOD TAX TREATMENT
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Less than one year ordinary incomeTAX TREATMENT FOR CAPITAL GAINS AND LOSSES
CATEGORIES OF GAIN
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depend on holding periods and tax treatmentHOLDING PERIOD TAX TREATMENT
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Less than one year ordinary income•
12 to 18 months max rate = 28%TAX TREATMENT FOR CAPITAL GAINS AND LOSSES
CATEGORIES OF GAIN
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depend on holding periods and tax treatmentHOLDING PERIOD TAX TREATMENT
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Less than one year ordinary income•
12 to 18 months max rate = 28%•
more than 18 months 20%*TAX TREATMENT FOR CAPITAL GAINS AND LOSSES
CATEGORIES OF GAIN
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depend on holding periods and tax treatmentHOLDING PERIOD TAX TREATMENT
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Less than one year ordinary income•
12 to 18 months max rate = 28%•
more than 18 months 20%**
unless taxpayer is in the 15% taxTAX TREATMENT FOR CAPITAL GAINS AND LOSSES
CATEGORIES OF GAIN
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depend on holding periods and tax treatmentHOLDING PERIOD TAX TREATMENT
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Less than one year ordinary income•
12 to 18 months max rate = 28%•
more than 18 months 20%*•
five years or more 18%**TAX TREATMENT FOR CAPITAL GAINS AND LOSSES
CATEGORIES OF GAIN
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depend on holding periods and tax treatmentHOLDING PERIOD TAX TREATMENT
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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%
TAX TREATMENT FOR CAPITAL GAINS AND LOSSES
CATEGORIES OF GAIN
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depend on holding periods and tax treatmentHOLDING PERIOD TAX TREATMENT
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Less than one year ordinary income•
12 to 18 months max rate = 28%•
more than 18 months 20%*•
five years or more 18%**INFLATION IN THE U.S.
INFLATION
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DEFINITION: the percentage change in a specific cost-of-living index at variouspoints in time.
INFLATION IN THE U.S.
INFLATION
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cost-of-living index
the “overall” price level computed for a“basket of goods”
INFLATION IN THE U.S.
PRICE INDICES
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measure changes in prices relative to afixed period in time usually called the base period
INFLATION IN THE U.S.
PRICE INDICES
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the Consumer Price Index (CPI) iscalculated by the U.S. Bureau of Labor Statistics in the Department of Labor
INFLATION IN THE U.S.
PRICE INDICES
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the Consumer Price Index (CPI) iscalculated by the U.S. Bureau of Labor Statistics in the Department of Labor
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the Bureau uses a “market basket” of over 2000 U.S. consumer goods and servicesINFLATION IN THE U.S.
NOMINAL AND REAL RETURNS
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Fisher Model of Real Returns stated that real returns are important to investors•
they represented how much purchasing power has changedINFLATION IN THE U.S.
NOMINAL AND REAL RETURNS
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price change may impact an asset’s nominal returnINFLATION IN THE U.S.
NOMINAL AND REAL RETURNS
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adjustments to the nominal return are needed to remove the effects onpurchasing power of inflation or deflation
INFLATION IN THE U.S.
NOMINAL AND REAL RETURNS
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FORMULA FOR CALCULATING REAL RETURNSwhere C0 = CPI at the beginning of period C1 = CPI at the end of the period
NR = the time period’s nominal return
1 0
1 C C NR
RR
INFLATION IN THE U.S.
NOMINAL AND REAL RETURNS
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a quick calculation of the real returnNR - IR = RR
where IR = the rate of inflation for the period NR= the nominal return
RR= the real return
INFLATION IN THE U.S.
THE EFFECT OF INVESTOR EXPECTATIONS
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investors’ attitudes toward inflation show they are concerned with real returnsINFLATION IN THE U.S.
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THE EFFECT OF INVESTOREXPECTATIONS Looking to the futureE(RR) = E(NR) - E(CCL)
where
E(RR) = the expected real return E(NR) = the expected nominal
return
E(CCL)= the expected inflation rate
STOCK RETURNS AND INFLATION
OVER LONG PERIODS OF TIME
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common stocks generated large, positive real returnsSTOCK RETURNS AND INFLATION
OVER LONG PERIODS OF TIME
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T-bills produced much lower, positive real returnsSTOCK RETURNS AND INFLATION
OVER SHORT PERIODS OF TIME
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stock returns are not positively related to either actual or expected rates of inflationSTOCK RETURNS AND INFLATION
