Federal Income Tax
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What is Income?
Annuities and Pension
- To determine tax for annuities, calculate an exclusion ratio and then you are taxed on the ratio multiplied by the yearly payout. See rule 72.
- For pensions, the employer contribution is taxable but the employee contribution is treated like the annuity (deferred taxation). Se rule 72.
Claim of Right
Transfer of property that is subject to Debt
- 172: Net operating loss carryovers
- Person A is taxed marginally at 40% and has $1M that he wants to invest entirely in bonds. Assume that the federal bond interest rate is 10% and the municipal bond interest rate is 8%. This means that the implicit tax rate on the municipal bond is 20%. If this person invests ALL of his money in bonds, he should invest in the tax free bonds so that he can get the 20% implicit tax rate on the interest earned from the investment.
- Person B is taxed marginally at 10% and has $1M that he wants to invest entirely in bonds. Assume that the federal interst rate is 10% and the minicipal bond interest rate is 8%. This means that the implicit tax rate on the municipal bond is 20%. If this person invests ALL of his money in bonds, he should invest in the federal bonds, so he keeps his 10% tax rate in the interest earned from the investment.
- Imagine person A does not have any liquid cash, but still has the marginal tax rate of 40%. Imagine he borrows $1M and has to pay $100k in interest every year and that he can deduct this interest from his other taxable income. If he can do this, he will use the $1M to purchase the tax free bonds. His interest from the bonds will be $80K, but he will save another $40K in tax every year in tax. He should keep lending and purchasing bonds, till the amount of his deductions will put him in a lower tax braket such that his margin tax rate is lower than the 20% implicit tax rate on the.