Tax Efficient Investing Flashcards
Current model
Earnings taxed annually (currently), reinvested earnings grow at the after-tax rate of return
Deferred model
Earnings taxed at the end of the investment period
Exempt model
Earnings exempts from explicit taxation /Current/Deferred Model with tax rate of 0, eg state and local government obligations and Roth IRAs
Pension model
Entire accumulation taxed at end of investment period, providing two levels of deferred taxation
Multi-period strategies
Optimize after-tax accumulation by investing in different types of investments at different stages
A Deferred Model investment will always outperform a Current Model investment when
the BTRORs and tax rates are constant over time and equal across both models
Mutual funds with low turnover rates
Passively managed and tax-managed/efficient funds
Premium/Discount considerations
If bonds yield taxable interest, can choose to amortize premium, if tax-exempt, must amortize.
When buying a market discount bond, can choose to accrue market discount over the period the bond is owned and include as interest income; otherwise any gain is ordinary interest income up to amount of accrued market discount and partial payment of principal on the bond must be treated as ordinary interest income, up to amount of accrued market discount. Method is called accretion
Ways to determine accretion (method of adjusting taxpayer’s cost basis of a bond bought at original issue discount
1) Ratable accrual method
2) Constant yield method
Wash sale rule
When taxpayer realizes loss on the sale of stocks/securities and acquires substantially similar stock/securities within a 61 day period- 30 days before and after the sale- to prevent artificial tax losses
Tax advantaged accounts
When investing money on a pre-tax basis, more income is generated since it is compounded tax-free/deferred; net unrealized appreciation that will eventually be charged as ordinary income; and would not hold tax exempt investments since it would be redundant
Ceasar bought a market discount bond and elected to not accrue the market discount over the period. Which of the following statements is CORRECT?
He must treat any gain when you dispose of the bond as ordinary interest income, up to the amount of the accrued market discount.
He must treat any partial payment of principal on the bond as ordinary interest income, up to the amount of the accrued market discount.
When you buy a market discount bond, you can choose to accrue the market discount over the period you own the bond and include it in your income currently as interest income. If you do not make this choice, the following rules generally apply.
You must treat any gain when you dispose of the bond as ordinary interest income, up to the amount of the accrued market discount.
You must treat any partial payment of principal on the bond as ordinary interest income, up to the amount of the accrued market discount.
Which of the following would trigger the ‘substantially identical’ requirement defined within the IRC regarding wash sales?
Convertible bond – can convert to stock which is the same stock that was sold for a loss.
Purchase of a call option that can be exercised into the same stock that was sold for a loss.
