Exam 3 Flashcards
Profits on stock investments are subject to ____ when held in a “regular” investment account
Income taxes
Stocks held in _____ accounts like 401(k) plans or IRAs, and college saving accounts like 529 plans, are not taxed while ______.
Retirement accounts
Inside the accounts
In regular investment accounts, investors pay taxes on each of the two components of their return, ___ and ____
Dividends
Realized capital gains or losses
Common and preferred stock dividends are taxed at:
0% for individuals in the ___ and __ bracket
15% for individuals in the ___, ___, ___, or ___ bracket
20% for individuals in the ___ bracket
0% for 10% and 12% bracket
15% for 22%, 24%, 32%, and 35% bracket
20% for 37% bracket
There is also a ___ surcharge tax for incomes over ____ for singles and ____ for married couples
3.8% surcharge
$200,000 for singles
$250,000 for married couples
Individuals must hold the stock for at least ___ days in the 121-day period beginning ___ days before the ex-dividend date, to get the favorable dividend tax rate
61 days
60 days
Dividends from Real Estate Investment Trusts (REITs) do not qualify for the favorable dividend tax rates, but there is a __% exclusion of REIT dividends from tax, so effectively REIT dividends get taxed at only ___% of the individuals ordinary tax rate
20% exclusion
80%
Dividends on stocks are taxable by __ and ___ governments that have income taxes
State and local governments
A capital gain is realized when you sell stock for ___ than you originally ___ for it
More
Originally paid
The amount you originally pay for a stock is referred to as the ____
Cost basis
The cost basis of a stock includes the ______ incurred to buy the stock. Similarly, when selling a stock, ___^ reduce the gain subject to tax
Brokerage commission
Capital gains are taxed only when ___
Realized
If appreciated stock or mutual fund shares are passed on to heirs upon death, _____ is owed on the gain realized by the deceased
NO capital gains tax
If Aunt Millie bought a share of Coca-Cola stock for $1 in 1965 and that share is worth $60 on the day that she dies, the $__ profit avoids _____ altogether. The cost basis for the heir receiving the Coca-Cola share is $___. This feature of the tax code is called the “____” at death
$59 profit
Capital gains tax
Cost basis is $60
“Step-up in basis”
Donation of _____ shares of stock directly to charity that have been held for more than ____, the current market value of the stock can’t be taken as an itemized _____, and capital gains tax is ____.
Appreciated
One year
Tax deduction
Avoided
Suppose you have 100 shares of stock that you bought four years ago for $5/share, and now the price is $20/share. By giving the 100 shares to charity, the charity gets full use of the $___ worth of stock, you get a $____ tax deduction, and avoid paying tax on the $____ capital gain.
$2000
$2000
$1500 capital gain
Capital gains are classified as short-term if the asset is held for __ months or less and long-term if held for more than ___ months
Short-term assets held for 12 months or less
Long-term assets held for more than 12 months
The tax rate on short-term capital gains is the ordinary ______.
The tax rate on long-term gains is the same _____ rate as ______.
Ordinary income tax rate
Special lower rate as dividends on common stocks
Capital ___ are first deduced against any capital ____, with ___ losses offsetting ___ gains, and ____ losses first offsetting ___ gains.
Losses
Gains
Short-term
Short-term
Long-term
Long-term
If total capital losses ____ capital gains, then they can be deducted against _____, like wages and salaries, up to $____. If the losses exceed gains by more than $___^ in a single year, the excess can be “___” without limit to future years to offset future capital gains or ordinary income
Exceed
Ordinary income
Up to $3000
$3000
“Carried forward”
Capital gains or losses on short sales are always considered ____, regardless of the holding period
Short-term
Two years ago you bought one share of a stock for $30 and now the stock price is $80. You earn a very good living, and have a 35% tax rate on ordinary income. Ignoring commissions, the capital gains tax you owe if you immediately sell the stock is ____
$80 - $30 = $50
Capital gains tax rate for assets held more than 12 months is 15%.
$50(.15) = $7.50
$7.50
If possible, hold winners for long periods, more than ____ at a minimum, deferring ___ on gains.
One year
Taxes
Suppose you bought 100 shares of FDX stock for $50/share on July 1, 2017, and the stock is trading for $70/share on July 1, 2018. You are in the 12% tax bracket. If you sell it on July 1, 2018, the holding period is 12 months, so it is a ___ gain. The tax owed is $___. If you wait until July 2, 2018 to sell, and the stock is still trading for $70, the tax owed on the ___ gain is $___.
Short-term gain
.12(100)($70-$50)= $240
Long-term gain
(.00)(100)($70-$50)= $0
Suppose you purchase a stock for $60 that does not pay dividends, and earns capital gains of 10% per year for 10 years. If you sell the stock after ten years and pay your taxes, and ignore brokerage costs, how much money do you end up with if you are in the 28% tax bracket?
Price of stock after 10 years:
FV = 60(1.1)^10 = $155.62
Since the stock is held more than 12 months, the long-term capital gains tax rate of 15% applies:
Tax= .15($155.62-$60)= $14.34
After taxes you end up with $155.62 - $14.34 = $141.28 after 10 years
$141.28
Suppose you invest your $60 in stocks but sell them within 12 months, and then buy other stocks. You repeat this cycle over 10 years. On average, you earn the same 10% per year before tax. If you are in the 28% tax bracket, and ignore brokerage costs, how much money do you end up with?
After-tax return= 10%(1-.28) = 7.2%
If you sell your stocks within 12 months, you pay taxes at 28% each year.
FV= 60(1.072)^10 = $120.25 after-tax after 10 years.
$120.25
$141.28 - $120.25 = $21.03 less than the buy and hold investor
Suppose you invest your $60 in stocks but sell them within 12 months, and then buy other stocks. You repeat this cycle over 20 years. On average, you earn the same 10% per year before tax. If you are in the 35% tax bracket, and ignore brokerage costs, how much money do you end up with?
Buy and hold investor vs. Active trader
Buy and hold:
FV = $60(1.1)^20 = $403.65
Tax = .15($403.65 - $60) = $51.55
After-tax, you have $352.10 after 20 years.
Active trader:
After-tax return = 10%(1-.35) = 6.5%
Sell within 12 months, pay 35% each year
FV = 60(1.065)^20 = $211.42 after-tax after 20 years
$352.10 - $211.42 = $140.68 less than the buy and hold investor
Sell losers quickly to realize _____: which on stocks can offset ____ on other stocks in a portfolio, or can offset taxes on ____ if there are no ____^ to offset
Capital losses
Realized gains
Ordinary income
Realized gains
Suppose you bought 50 shares of Disney for $45 and the price is $30 six months later. If you sell, you realize a short-term loss of $___, saving $___ if you are in the 28% bracket. Assuming a modest 6% annual return, you can earn $___ on the tax savings in the first year
$15 per share loss
.28(50)($15) = $210
Saving $210
6% annual return:
.06($210) = $12.60 on tax savings
If you have already realized (or anticipate realizing) both short-term and long-term capital gains in a given year, it is best to sell any _____ losers in your portfolio before they become ____.
Short-term losers
Before they become long-term losers
By taking a short-term loss rather than a long-term loss, you can offset short-term gains rather than long-term gains, and thus reduce your total ____.
Tax bill
If you sell a stock at a loss, and buy the same stock within a period beginning ___ days before and ending ___ days after the sale, you cannot take a ___ for __ purposes
30 days
30 days
Capital loss for tax purposes
Nothing stops you from selling a loser and then buying a ___ stock. If auto stocks are depressed, but you think they will recover, you can sell GM at a loss for ___ purposes, and buy Ford.
Similar
Tax
For many people, _____ will be their largest and most important financial investment
Stock mutual funds
Mutual fund rating services, like Morningstar and Lipper, classify stock funds into several different categories, based on the _____ objectives and policies. While these classifications are not precise, they give some guidance about ___ and ___.
Fund’s stated investment
Risk and potential return
These funds buy stocks with high capital gain potential and relatively high risk
Growth
___ funds buy ___ stocks, stocks with relatively low P/E and P/B ratios. These stocks often pay higher _____ than growth stocks
Value
Value
Dividend yields
These funds buy stocks with roughly the same risk and expected return as the average or typical stock
Blend
Large-cap funds buy ___ company stocks, and so forth. Morningstar classifies funds into a 3-by-3 grid, with ___, ___, and ___ on one axis, and ___, ___, and ___ on the other
Large company stocks
Growth, blend, and value on one axis
Large, mid, and small cap on the other
Index funds attempt to match the returns of a _____ of stocks
Diversified index portfolio
Small stock index
Russell 2000
Comprehensive index of virtually all actively-traded stocks in the U.S.
CRSP U.S. Total Market Index
Indexing strategy:
You try to do ___ the overall market
As well as
Specialize in one sector of the market, such as health care, oil, computers, etc.
Sector funds
___ funds invest in the U.S. and abroad, while ___ funds focus only outside the United States
Global
International
Fees on international mutual funds are almost always ___ than on domestic funds. This is because trading is usually _____ on foreign stock exchanges than in the United States, and research is more ___ and ___
Higher
More costly
Difficult and costly
Younger individuals in particular should consider investing some of their portfolio into ___ stock funds. Emerging markets have considerable ____, though relatively high ___, including ___ and ___ risk
International
Growth potential
Risk
Political and Exchange rate risk
A number of stock (and hybrid) mutual funds invest based on social criteria, generally avoiding corporations making tobacco, alcohol, nuclear power, and other products considered undesirable
Socially Responsibly Funds
Investment strategy:
Make sure your own ____ is consistent with the fund’s stated ____
Risk tolerance
Investment strategy
Historical returns:
Look for a fund that earns returns ___ the ___ for its style over the past __ to __ years
Above the average
5-10 years
Expenses and loads:
As a rule, choose a ___ fund with ___ expenses
No-load
Below-average
Age of fund and tenure of manager:
For an actively-managed fund with a good track record, make sure the manager that earned the high returns is ___. If a new manager is in charge, there is no reason to believe past _____ will persist
Still there
Superior performance
Size of fund:
Large stock trades tend to have a significant “____”
Market impact
Diversification:
If you hold only one or two stock mutual funds in your overall portfolio, make sure the funds are _____, both in terms of the ____ and ____
Well-diversified
Number of stocks held and industry concentration
Tax Efficiency refers to the fund’s effectiveness in limiting the ____ of fund shareholders for any given ____ total return
Tax liabilities
Before-tax
These funds try to hold appreciated stocks for more than 12 months to get the lower capital gains tax rate, and to hold on for as long as possible thereafter to defer capital gains taxes for shareholders. They also sell losing stocks quickly to realize tax losses
Tax-managed funds
Turnover:
High turnover usually produces high ______ and high _____ for fund shareholders
Capital gain realizations
Tax liability
Frequent trading can also ___ returns in a more subtle way, through paying the ____ to buy and sell, and also the “___” of trading
Bid-ask spread
“Market impact”
The higher the turnover of a mutual fund, the higher will be the capital gains taxes paid by investors. True or false?
True
