# 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.

## Statutes

• 172: Net operating loss carryovers

## Tax Arbitrage

• 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.