Solution: Increases in top Personal rate on interest and dividends to 35% Tax on

Question

Solution:

Increases in top Personal rate on interest and dividends to 35%

Tax on realized capital gains at 15%. Corporate tax stays at 35%.

Assumption:

It is assumed that the investor is in top personal bracket.

Answer a: All capital gains are realized immediately

If the investor gets $1 as interest, it is taxed at the rate of 35% for the investor.

Realization for the individual will be

= ($1 - 35%) or $ (1-0.35)

= $ 0.65

If a corporate pays an individual $0.50 as dividend and $0.50 as capital gain, then,

·         * for corporate the tax will be 35%,

·         * dividend income for individual will be taxed at 15% and

·         * for capital gains, if realized immediately, will be 35%.

On the basis of above the amount received by investor after tax will be:

            = $0.50*(1-0.35)*(1-.015) + $0.50*(1-0.35)*(1-.035)

            = $0.50*0.65*0.85 + 0.50*0.65*0.65

            = $0.4875

Answer b: If Capital gains are deferred forever

If $1 interest is paid by corporate the tax rate is 35% for individual and the realization will be $0.65.

If the individual is paid $0.50 as dividend and $0.50 as capital gain deferred forever, then,

·         * for corporate tax will be 35% on dividends,

·         * dividend income for individual will be taxed at 35% and

·         * for investor tax will be 15% on capital gain deferred.

On the basis of above the amount received by investor after tax will be:

= $ 0.50*(1-0.35)*(1-0.15) + $ 0.5*(1-0.35)*(1-0.15)

= $0.5*0.65*0.85 + $0.5*0.65*0.85

= $ 0.27625 + 0.27625

= $ 0.56

Explanation / Answer

Default sales trustes are effective capital gain tax-deferred strategies, but without the risk of buyer default because the Trust receives 100 percent cash proceeds from the buyer at the closing of the transaction, thus removing the buyer from the equation. The capital gains tax is realized or triggered, but not recognized or paid. The capital gains tax liability can be fully tax deferred over the term of the installment sale note created within the Deferred Sales Trust account, which can be negotiated in advance directly with the Trustee of the Deferred Sales Trust. Thus option B is better as you can save on the amount of tax paid ; so as shown in the calculation your take home is 0.56 vs 0.4875 In option B there is no risk as you receive the payment upfront as written above.

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