Depreciation and Section 179 deduction

Barry Dolowich for the Monterey Herald writes: Question: I expanded my business in 2014 and purchased a significant amount of furniture, fixtures and equipment. Will I be able to deduct all these purchases on my 2014 tax returns? In addition, will the rules be the same in 2015 if I continue to expand?

A You will be able to deduct part or all of your expenditures in 2014 to help offset your income, reducing your tax obligation. The furniture, fixtures and equipment you purchased are considered capital asset expenditures subject to specific depreciation rules. Generally, the cost of these assets must be depreciated over a specified recovery period (five or seven years). This means that you will be claiming a depreciation deduction (spreading the cost) throughout the respective recovery periods.

However, an expense deduction is provided for taxpayers (other than estates, trusts or certain noncorporate lessors) that elect to treat the cost of qualifying property, called Section 179 property, as an expense rather than a capital expenditure. Section 179 property includes all personal property (not real property) used in a trade or business for the production of income. A car or truck can qualify as Section 179 property. The election, which is generally made on Form 4562, is attached to the taxpayer’s original tax return for the year the property is placed in service. Individuals (sole proprietors) attach Form 4562 to their Form 1040, and corporations and partnerships attach Form 4562 to their respective business tax returns. Employees may make the election on Form 2106, also attached to Form 1040.

The Section 179 deduction allows you to choose to treat part or all of the cost of the equipment and furniture as an expense, rather than taking depreciation deductions over many years. As an expense, the Section 179 amount is deductible only in the year the assets are placed in service. For this purpose, “placed in service” means the year you first used the assets for business purposes.

For 2014, the tax law allows you to treat up to $500,000 of the cost of qualifying property as a Section 179 deduction. The 2014 maximum amount is reduced by a dollar for each dollar of the cost of qualified property placed in service during the tax year over $2 million. If you take the maximum Section 179 deduction of $500,000, you can still depreciate the excess cost over $500,000 of the assets over a period of years.

In addition, most new property placed in service during 2014 also qualifies for a bonus 50 percent first-year depreciation allowance. The bonus allowance is applied to the property’s adjusted basis as reduced by any Section 179 expensing for the property, and regular depreciation is applied to the property’s adjusted basis after a reduction to reflect the bonus depreciation allowance.

If you dispose of the assets on which you had claimed the Section 179 deduction, the amount of that deduction is treated as a depreciation deduction for recapture purposes. Any gain on the disposition of the property is treated as ordinary income up to the amount of the Section 179 deduction and any depreciation you claimed.

The total cost of property that may be expensed for any tax year pursuant to Section 179 cannot exceed the total amount of taxable income derived from the active conduct of any trade or business during the tax year (the deduction cannot create a loss). A deduction disallowed under this rule is carried forward an unlimited number of years subject to the ceiling amount for each year. Special rules also apply for assets used for both personal and business purposes.

On Dec. 19, 2014, President Barack Obama signed the Tax Increase Prevention Act of 2014 extending the $500,000 Section 179 deduction limit through 2014 only. The Section 179 limit will return to the $25,000 level (with a $200,000 investment limit) in 2015 unless Congress takes action to extend it again.

I recommend that you consult with your tax adviser to determine the best strategy to utilize the Section 179 deduction and/or bonus depreciation.

Kositzka Wicks Company writes:

ANSWERS TO YOUR QUESTIONS ABOUT MARITAL STATUS AND TAX RETURNS

When a couple ties the knot or gets divorced, taxes are probably not the first thing on their minds. But many decisions that couples make do affect their tax returns — and the amount they ultimately owe the federal government.

Here are some answers to some frequently asked questions about marital status and taxes.

Q. What if I get married (or divorced) during the year?

A. You’re considered married for the whole year if, on the last day of the year, you and your spouse meet any one of the following tests:

You are married and living together as husband and wife.

You are living together in a common-law marriage that is recognized in the state where you now live or in the state where the common-law marriage began.

You are married and living apart, but not legally separated under a decree of divorce or separate maintenance.

You are separated under an interlocutory (not final) decree of divorce.

Q. What if my spouse died last year? How is it handled on my tax return?

A. If your spouse died during the year, you are considered married for the whole year for filing status purposes. If you did not remarry before the end of the year, you can file a joint return for yourself and your deceased spouse.

If you have at least one dependent child you may be eligible to use qualifying widow(er) with dependent child as your filing status for two years following the death of your spouse. This filing status entitles you to use joint return tax rates and the highest standard deduction amount (if you don’t itemize). However, the status does not entitle you to file a joint return.

Q. If I am married, does it pay to use “married filing separately” status?

A. Many married taxpayers seem to think it would be advantageous to file their returns as married, filing separately, rather than as joint. However, only rarely does this filing method save taxes. You report only your own income, exemptions, credits and deductions on your individual return. But then, your spouse must also itemize.

There are other limitations. For example, in most instances you can’t take the credit for child and dependent care expenses, you cannot take the education credits, your capital loss deduction is limited to $1,500 (not $3,000), etc. On the other hand, there are some combinations of spousal income and deductions where married filing separately will save taxes. Best advice? Ask your tax adviser if filing separately would be beneficial.

Q. Can I deduct legal and accounting fees incurred in my divorce?

A. It depends. Certain fees may be deductible.

For example, tax planning advice related to the divorce and legal fees incurred in securing alimony may be deductible. But you’ve got to be prepared to show the relationship and the amount of the fees. That means any bills from your attorney, accountant, etc. should show a breakdown of the time and charges with details of the services rendered. Taxpayers are often denied deductions for attorney and accountant fees when invoices do not break out fees related to tax planning or taxable income.

Q. For tax purposes, is there anything I should do if I change my name due to a recent marriage or divorce?

A. If you changed your name after a recent marriage or divorce, take the necessary steps to ensure the name on your tax return matches the name registered with the Social Security Administration (SSA).

Here are five tips from the IRS for recently married or divorced taxpayers who have a name change.

If you took your spouse’s last name — or if you hyphenated your last names, notify the SSA. When newlyweds file a tax return using their new last names, IRS computers can’t match the new name with their Social Security number. A mismatch between the name shown on your tax return and the SSA records can cause problems in the processing of your tax return and may even delay your refund.

If you recently divorced and changed back to your previous last name, you also need to notify the SSA of this name change.

To inform the SSA of a name change, simply file a Form SS-5, Application for a Social Security Card, at your local SSA office or by mail and provide a recently issued document as proof of your legal name change.

Form SS-5 is available on SSA’s website at http://www.socialsecurity.gov/, by calling 800-772-1213 or at local offices. A new card will have the same number as your previous card, but will show your new name.

If you adopted your spouse’s children after getting married and their names changed, you’ll need to update their names with SSA too. For adopted children without SSNs, the parents can apply for an Adoption Taxpayer Identification Number — or ATIN — by filing Form W-7A, Application for Taxpayer Identification Number for Pending U.S. Adoptions with the IRS. The ATIN is a temporary number used in place of an SSN on the tax return.

Q. What is the difference between an injured spouse and an innocent spouse?

A. When a married couple files a joint tax return, they are both “jointly and severally” liable for the tax — and any tax additions, interest and penalties that arise — even if they later divorce. They are also both responsible even if one spouse earned all of the income or claimed improper deductions or credits. This means the IRS can go after either spouse for the entire amount owed.

As you can imagine, this creates problems because one high-earning spouse could disappear and the IRS could pursue the spouse who is easier to find — but did not earn the money or cause the issues on the tax return. For these people, there may be “innocent spouse” relief. Under the rules, a spouse must prove he or she was unaware of the activities that caused the tax and did not benefit financially. If a spouse or former spouse qualifies, he or she will be relieved of the tax, interest and penalties on a joint tax return.

There are separate rules for “injured spouses.” You are an injured spouse if your share of a tax refund shown on your joint return is applied (or offset) against your spouse’s legally enforceable past-due federal taxes, state income taxes, state unemployment compensation debts, child or spousal support payments or federal non-tax debt, such as a student loan. If you are an injured spouse, you may be entitled to receive your share of the refund.

Sometimes Being Smart Isn’t an Advantage when it Comes to Dealing with the IRS

In one case, a wife who signed a joint return tried to claim innocent spouse treatment. The court sided with the IRS in finding that even though she didn’t read the return, she had constructive knowledge of the data in the return.

The understatements on the tax return were substantial and the court noted that the wife was not only well-educated, she had her own business and should have known there was a problem. Finally, the court found the wife had a responsibility to review the return.  

To Visit KWC click here.

Three big tax and retirement savings changes for 2015

Steve Nicastro for The Christian Science Monitor writes: Three big financial changes took effect at the start of 2015, and you should be aware of them if you're seeking to give your finances a new beginning. Read on for important new rules on retirement contributions, tax brackets, and more. 

The New Year is all about change and getting a fresh start, like setting personal resolutions to improve your physical and mental well-being. But our financial health often gets overlooked.

If you’re seeking to give your finances a new beginning in 2015, it’s vital to be aware of these three important financial changes that took effect at the start of the New Year.

1. Contribution limits on retirement, flexible spending accounts rise

Want to save more for your retirement in 2015? Well, you’re in luck: The contribution limit for a 401(k), 403(b), most 457 plans and the federal government’s Thrift Savings Plan has been increased to $18,000, a $500 bump from 2014. And if you’re age 50 or older (or turning 50 anytime before Dec. 31, 2015), you’ll be able to stash away an additional $6,000 as a catch-up contribution, a $500 increase from 2014.

What if you’re self-employed or a small-business owner with a Simplified Employee Pension (SEP) IRA? Good news: You’ll be able to contribute $53,000 to the account in 2015, a $1,000 boost from last year.

IRA contribution limits remain the same: $5,550 for total contributions to all of your traditional and Roth IRAs, or $6,500 if you’re age 50 or older. However, the contribution limit on a flexible spending account (FSA) — a tax-advantaged account that you put money into to pay for qualified out-of-pocket health care expenses — is now $2,550, a $50 increase from 2014.

2. Income tax brackets, deductions adjusted upward

Now that 2014 is in the books, tax season is approaching and there are a few changes for 2015 to note. Before meeting with your accountant, it’s important to understand your tax bracket, personal exemptions and eligible deductions, so you can properly file your taxes and get all of the savings you’re entitled to.

Tax brackets: Your tax bracket is based on your total taxable income, so this includes all sources of income such as wages, bonuses, tips, interest and dividends, freelance income, commissions, unemployment benefits and severance pay. You’ll use 2014 tax brackets to prepare your tax returns in 2015.

For 2014, single filers earning between $36,901 and $89,350 a year will pay a 25% tax rate, while those who earned $89,351 to $186,350 will pay a 28% rate. Married couples filing jointly that earned between $73,800 and $148,850 will pay a 25% rate, whereas those earning between $148,850 and $226,850 will pay 28%.

In 2015, tax brackets will be adjusted upward for inflation, so keep this in mind when preparing and filing your 2015 tax returns in 2016. More information can be found at the IRS’ revenue procedure document.

Deductions: Remember, you can take deductions to reduce the amount of your taxable income. The IRS allows taxpayers to either itemize deductions, in which you report deductions individually, or take a standard deduction, a predetermined dollar amount. Examples of popular itemized deductions include home mortgage interest, property taxes, medical expenses and charitable contributions.

For 2015, the standard deduction amount has been bumped up $100 to $6,300 if you’re single or married filing separately. For those married filing jointly, the deduction is increased $200 to $12,600.

Generally speaking, it’s a good idea to itemize deductions if your allowable deductions are greater than the standard deduction amount given by the IRS. So if you’re absolutely certain your total itemized deductions in 2015 will exceed the standard deduction, itemizing will likely make more sense.

Personal exemptions: Taking a personal exemption is another way to decrease your taxable income. In general, you are allowed to take an exemption for yourself — as long as you are not claimed as a dependent by another taxpayer — and for qualifying family members. For 2015, the personal exemption amount is $4,000, which is up $50 from $3,950 in 2014.

For those with high incomes, keep in mind that the exemption may be reduced or eliminated completely. In 2015, the personal exemption is subject to a “phaseout” if you earn more than $258,250 in adjusted gross income (or $309,900 for married couples filing jointly), and it’s phased out completely at $380,750 ($432,400 for married couples filing jointly).

3. Social Security checks, tax caps expand

There are a few key changes for Social Security in 2015.

For one, recipients of Social Security are receiving 1.7% bigger checks in 2015 due to an annual cost-of-living increase. This has lifted the average monthly benefit for retired workers from $1,306 to $1,328, according to the Social Security Administration. In addition, the maximum Social Security benefit for a worker retiring at his or her full retirement age has increased to $2,663 per month in 2015, a $21 jump from 2014.

There is also a higher tax cap on Social Security. Workers pay 6.2% of every paycheck into Social Security until their earnings exceed the tax cap, and the amount of wages subject to the Social Security tax has increased from $117,000 in 2014 to $118,500 in 2015.

For those without an online account, the Social Security Administration will now mail out paper statements. Workers turning age 25, 30, 35, 40, 45, 50, 55 and 60 will receive a statement three months before their birthdays, according to the AARP.

Tax efficiency concern? : a discussion

Over at Bogleheads we came across the following discussion:

Tax efficiency concern?

Post a reply

16 posts • Page 1 of 1

Tax efficiency concern?

by Gecko10x » Tue Jan 06, 2015 11:12 am

This year I will probably start putting funds into a taxable account to be used for a future house. My basic question is: How much, if any, should I be concerned about the tax efficiency of my investments?

We are currently in the 15% tax bracket, and will likely be there for 2015, but beyond that we may get pushed up into 25%.

My preferred long-term portfolio is:

35% SCHP (Schwab TIPS)

15% SCHR (Schwab Interm. Treasury)

15% RPV (Guggen. 500 Value)

13% RZV (Guggen. Small Value)

6% SCHC (Schwab Int. Small)

6% FNDF (Schwab Fundamental Int. Large)

5% SCHE (Schwab Emerging)

5% SCHH (Schwab REIT)

As this will not really be a long-term portfolio, I may consider adjusting the stock/bond split, or the tilt. However, as my timeline is pretty open-ended, I may also consider just sticking with the above, barring any tax-efficient adjustments.

I'm just not quite sure where to start in evaluating. How tax-efficient are the above ETFs (And where do I find this info)? Even if they arebad, how much of a difference does it really make? Do I stick with those until we are in the 25% bracket, then worry about it?

P.S. - I see that Schwab lists a "Tax Cost Ratio" for each ETF, which seems to be in the range of 0.5 - 1. What exactly does this mean?

Edit: P.S. answer:

Tax Cost Ratio represents the percentage-point reduction in returns that results from Federal income taxes (before shares in the fund are sold, and assuming the highest Federal tax bracket). Example: if a fund has a 10% pre-tax return, and taxes reduce that return to 9%, then the tax cost ratio is 1.00.

Last edited by Gecko10x on Tue Jan 06, 2015 12:32 pm, edited 3 times in total.

Gecko10x

Posts: 110

Joined: Thu Jun 06, 2013 8:10 pm

Top

Need fund names

by Taylor Larimore » Tue Jan 06, 2015 11:25 am

Gecko:

I doubt if anyone has memorized the ticker symbols. It will be helpful, and you will get more replies, if you edit your post to include the name of the funds. Use the "edit" button at the top of your window.

Thank you and best wishes.

Taylor

"Simplicity is the master key to financial success." -- Jack Bogle

Taylor Larimore

Advisory Board

Posts: 20454

Joined: Tue Feb 27, 2007 8:09 pm

Location: Miami FL

Top

Re: Need fund names

by Gecko10x » Tue Jan 06, 2015 11:29 am

Taylor Larimore wrote:Gecko:

I doubt if anyone has memorized the ticker symbols. It will be helpful, and you will get more replies, if you edit your post to include the name of the funds. Use the "edit" button at the top of your window.

Thank you and best wishes.

Taylor

Added.

Gecko10x

Posts: 110

Joined: Thu Jun 06, 2013 8:10 pm

Top

Re: Tax efficiency concern?

by Taylor Larimore » Tue Jan 06, 2015 11:57 am

Gecko:

If you are saving for a house in the near future, you should not be investing in stocks unless you have substantial savings elsewhere. In your attempt to achieve higher return, there is a good chance you will not achieve your goal. Stocks regularly plunge 30% to 50% or more (there goes your house).

Your "tax efficiency concern" for a short term investment is way down on what's important--especially if you are in a low-income tax bracket. Your savings for a house should probably be in CDs or a short-term bond fund (better liquidity).

You may find this Vanguard article helpful:

Your Investing Life: Buying your first home

Best wishes.

Taylor

"Simplicity is the master key to financial success." -- Jack Bogle

Taylor Larimore

Advisory Board

Posts: 20454

Joined: Tue Feb 27, 2007 8:09 pm

Location: Miami FL

Top

Re: Tax efficiency concern?

by Gecko10x » Tue Jan 06, 2015 12:05 pm

Taylor, thanks for the advice.

I agree; the reason for my waffling on the AA is that the timeline is going to be 10+ years... probably somewhere in the 11-15yr range. In addition, I don't have a problem waiting 1-3yrs for a recovery. So, for me that puts it just within the "stocks are OK" range. Although I likely wouldn't be happy with a large crash near the end and a slow recovery, so if I start with a decent stock allocation, I'll likely trim it as I near my goal.

Gecko10x

Posts: 110

Joined: Thu Jun 06, 2013 8:10 pm

Top

Re: Tax efficiency concern?

by Taylor Larimore » Tue Jan 06, 2015 12:38 pm

Gecko:

Gecko10x wrote:Taylor, thanks for the advice.

I agree; the reason for my waffling on the AA is that the timeline is going to be 10+ years... probably somewhere in the 11-15yr range. In addition, I don't have a problem waiting 1-3yrs for a recovery. So, for me that puts it just within the "stocks are OK" range. Although I likely wouldn't be happy with a large crash near the end and a slow recovery, so if I start with a decent stock allocation, I'll likely trim it as I near my goal.

Gecko:

With a minimum 10+ year timeline I think it is reasonable to hold a portfolio of bonds and stocks. And yes, tax-efficiency is important.

Consider saving in a Roth for the down-payment. You and your spouse could contribute a total of $13,000/year and withdraw thecontributions (plus $20,000 earnings) whenever you wish--all tax-free. Consider a diversified Target Fund with the stock/bond ratio you want; 60% stocks/40% bonds might be reasonable. Exchange to a different Target Fund holding more bonds as you approach your purchase date.

If you decide you must use a taxable account for saving, consider Total Stock Market Index Fund for its diversification (less risk) and tax-efficiency for the stock portion.

Best wishes.

Taylor

"Simplicity is the master key to financial success." -- Jack Bogle

Taylor Larimore

Advisory Board

Posts: 20454

Joined: Tue Feb 27, 2007 8:09 pm

Location: Miami FL

Top

Re: Tax efficiency concern?

by Gecko10x » Tue Jan 06, 2015 12:55 pm

Tax Cost Ratio represents the percentage-point reduction in returns that results from Federal income taxes (before shares in the fund are sold, and assuming the highest Federal tax bracket). Example: if a fund has a 10% pre-tax return, and taxes reduce that return to 9%, then the tax cost ratio is 1.00.

Tax Cost Ratios (1yr annualized):

35% SCHP (Schwab TIPS) ..................... 0.48

15% SCHR (Schwab Interm. Treasury) ...... 0.54

15% RPV (Guggen. 500 Value) ............... 0.8

13% RZV (Guggen. Small Value) ............ 0.61

6% SCHC (Schwab Int. Small) ............... 1.16

6% FNDF (Schwab Fundamental Int. Large) 1.55

5% SCHE (Schwab Emerging) ................ 0.85

5% SCHH (Schwab REIT) ..................... 2.00

Weighted total for above = 0.75

For reference, AOM (iShares Moderate Allocation ETF) was 1.49

So, the above portfolio doesn't seem too bad(?), especially considering my drag will be significantly less, even in the 25% bracket. I could make it a little better by dropping the REIT fund, and maybe looking for alternative international funds.

Gecko10x

Posts: 110

Joined: Thu Jun 06, 2013 8:10 pm

Top

Re: Tax efficiency concern?

by abuss368 » Tue Jan 06, 2015 1:26 pm

Hi Gecko,

Taylor has provided excellent advice. Personally I think you have too many funds. More funds involve increased complexity from rebalancing, tax reporting, and overall paperwork and administration. If you are going to go the Vanguard route, consider a much more simplified portfolio that will be as effective or more. I would suggest the "Three Fund Portfolio" comprising of Total Stock Index, Total International Index, and Intermediate Term Tax Exempt. There is an excellent Three Fund Portfolio thread on this forum that I would recommend taking time to read through.

Best.

John C. Bogle: "You simply do not need to put your money into 8 different mutual funds!" | | Disclosure: Three Fund Portfolio + REITs

abuss368

Posts: 6801

Joined: Mon Aug 03, 2009 2:33 pm

Location: At the Beach

Top

Re: Tax efficiency concern?

by Gecko10x » Tue Jan 06, 2015 2:02 pm

abuss368 wrote:If you are going to go the Vanguard route, consider a much more simplified portfolio that will be as effective or more. I would suggest the "Three Fund Portfolio" comprising of Total Stock Index, Total International Index, and Intermediate Term Tax Exempt.

I'm not. But just for the argument's sake, lets say I was; How do I compare the tax efficiency of your suggested funds to my own? The best I can find is 1yr before/after tax returns. Is this correct and comparable to the Schwab tax ratios? Is there a better way to get this info?

I don't see an ETF version of Intermediate Term Tax Exempt, and I'm not all that interested in using funds. Here's the closest I see to your suggestion using ETFs, with the 1yr before/after tax return differences:

VTI: 0.48

VEU: 0.9

VGIT: 0.7

Assuming a 25/25/50 split, that gives me a weighted average tax drag of 0.7 (again, assuming I'm doing this correctly). This is quite comparable to my portfolio. Granted, you suggested the tax exempt bond fund (which appears to have 0 tax drag), but I am not a fan of funds, especially for small portfolios. Is there something I'm missing? Am I dismissing the fund route too easily?

Respectfully, I get the feeling my actual question is being skirted to poke at my AA and fund choice. I am only interested in debating my AA as it relates to tax efficiency.

Gecko10x

Posts: 110

Joined: Thu Jun 06, 2013 8:10 pm

Top

Re: Tax efficiency concern?

by bhsince87 » Tue Jan 06, 2015 2:16 pm

Trying to calculate the tax drag could be very complicated in your situation.

While you are in the 15% bracket (up to possibly $85-95k per year income), the taxes on cap gains and qualified dividends for the stock funds will be zero. So there will be no significant "tax drag" from those. However, income from the REITs and bond funds will be taxed at 15%. So there is indeed a drag there.

If/when you move into the 25% bracket, dividends and cap gains will be taxed at 15%, but interest and income from the REIT and bond funds will be taxed at 25%. So both will have a tax effect, but one group will be less impact than the other.

To get an accurate picture of the real tax drag, you need to factor those differing rates into your calculations.

BH87

bhsince87

Posts: 717

Joined: Thu Oct 03, 2013 1:08 pm

Top

Re: Tax efficiency concern?

by livesoft » Tue Jan 06, 2015 2:22 pm

I try to be very tax-efficient. Are you asking Does it matter? I think so in the long run.

Every bit one pays for taxes is a drag on the portfolio performance. It is like an increase in the expense ratio if one is not careful. Also, worse tax efficiency can creep up on one with long-term investing. For instance, one may think, "Oh, I'm in the 15% tax bracket now, so no big deal." But that may not always be the case or tax laws can change. And as one's portfolio gets larger, the dividends and distributions from funds / ETFs / stocks start to really add up and one cannot easily lower them without incurring a huge realized capital gain and the taxes that go with that. Then there can be surprises such as an index fund paying out a distribution of 10% of the share value.

Also the "tax-cost ratio" or whatever one wants to call it really does depend on one's personal tax situation. One may have offsetting losses to help with long-term capital gains distributions or one may have qualified dividends taxed at 0% or whatever. The reported tax costs are suspicious and the conventional wisdom is suspect, too. For instance, I think for 2014 that it will turn at the the Total Int'l Stock Market Index fund will be much less tax-efficient than it has been in the past while the FTSE all-world ex-US small-cap index fund will be much more tax-efficient than it has been in the past. One needs a little research and a spreadsheet to determine all these things for themselves. Each year is different, too, so 2015 will be different from 2014.

All one can hope for is that one tries not to do much worse that Total US Stock Market index which for 2014 has a tax-cost of about 0.3% for someone in the 25% marginal income tax bracket. That's like an added 0.3% to the expense ratio. So as long as one can get all their taxable investments under 0.35%, I think they are doing pretty well.

As far as down payment for house goes, probably the worst tax efficiency is a CD or savings account which is often suggested, so even a fund with poor tax efficiency could be better. But why bother with poor tax efficiency when one doesn't have to?

This signature message sponsored by LadyGeek.

livesoft

Posts: 35733

Joined: Thu Mar 01, 2007 8:00 pm

Top

Re: Tax efficiency concern?

by Gecko10x » Tue Jan 06, 2015 2:28 pm

bhsince87 wrote:Trying to calculate the tax drag could be very complicated in your situation.

While you are in the 15% bracket (up to possibly $85-95k per year income), the taxes on cap gains and qualified dividends for the stock funds will be zero. So there will be no significant "tax drag" from those. However, income from the REITs and bond funds will be taxed at 15%. So there is indeed a drag there.

If/when you move into the 25% bracket, dividends and cap gains will be taxed at 15%, but interest and income from the REIT and bond funds will be taxed at 25%. So both will have a tax effect, but one group will be less impact than the other.

To get an accurate picture of the real tax drag, you need to factor those differing rates into your calculations.

Just the kind of info I need

That said, do you not think this would already be accounted for by Schwab/Vanguard?

Gecko10x

Posts: 110

Joined: Thu Jun 06, 2013 8:10 pm

Top

Re: Tax efficiency concern?

by Gecko10x » Tue Jan 06, 2015 2:41 pm

I appreciate your thoughts, Livesoft.

livesoft wrote:Also the "tax-cost ratio" or whatever one wants to call it really does depend on one's personal tax situation. One may have offsetting losses to help with long-term capital gains distributions or one may have qualified dividends taxed at 0% or whatever. The reported tax costs are suspicious and the conventional wisdom is suspect, too. For instance, I think for 2014 that it will turn at the the Total Int'l Stock Market Index fund will be much less tax-efficient than it has been in the past while the FTSE all-world ex-US small-cap index fund will be much more tax-efficient than it has been in the past. One needs a little research and a spreadsheet to determine all these things for themselves. Each year is different, too, so 2015 will be different from 2014.

Understandable... but is there anything I can really do about it? Other than just pick the funds that have been most tax efficient in the past?

livesoft wrote:All one can hope for is that one tries not to do much worse that Total US Stock Market index which for 2014 has a tax-cost of about 0.3% for someone in the 25% marginal income tax bracket. That's like an added 0.3% to the expense ratio. So as long as one can get all their taxable investments under 0.35%, I think they are doing pretty well.

That's a good benchmark, thanks

livesoft wrote:As far as down payment for house goes, probably the worst tax efficiency is a CD or savings account which is often suggested, so even a fund with poor tax efficiency could be better.

OK, so.. why are those the worst? (I feel like that's a dumb question )

Gecko10x

Posts: 110

Joined: Thu Jun 06, 2013 8:10 pm

Top

Re: Tax efficiency concern?

by livesoft » Tue Jan 06, 2015 2:48 pm

Gecko10x wrote:IUnderstandable... but is there anything I can really do about it? Other than just pick the funds that have been most tax efficient in the past?

And avoid the funds that have NOT been tax-efficient in the past like REITs.

livesoft wrote:OK, so.. why are those the worst? (I feel like that's a dumb question )

Suppose a CD pays 3% per year, what is the tax-cost ratio for someone in the 25% marginal income tax bracket if the CD is held in a taxable account?

This signature message sponsored by LadyGeek.

livesoft

Posts: 35733

Joined: Thu Mar 01, 2007 8:00 pm

Top

Re: Tax efficiency concern?

by Gecko10x » Tue Jan 06, 2015 5:06 pm

Thoughts on excluding world markets to get taxes down?

On one hand, I'd hate to give up all that diversification. OTOH, there's lots of diversification within the US market, and plenty of international exposure via LC. Plus, with a decreasing equity exposure, would it really matter much?

Gecko10x

Posts: 110

Joined: Thu Jun 06, 2013 8:10 pm

Top

Re: Tax efficiency concern?

by livesoft » Tue Jan 06, 2015 5:21 pm

Foreign ETFs and funds are trickier to judge the tax cost because one pays foreign taxes regardless of whether one gets a foreign tax credit or not and all the returns are really quoted post-foreign-tax anyways. For instance, when dividends are paid, one doesn't even know what the taxes are until a 1099-DIV shows up months later.

That said, if you include the foreign taxes and the US taxes, the tax hit is about 0.6% for foreign funds. If you get the foreign tax credit, then the tax hit is between 0.08% and 0.4% for the additional US taxes. I think it is worthwhile owning foreign equities. One saves so much money from tax-loss harvesting!

Oh, none of this takes into account the capital gains taxes from selling and realizing gains nor the benefits of losing money and selling at a loss.