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Taxes - and impact on ones strategy


kab60
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I've only been investing for a year and a half and is obviously still evolving my style, and I'm trying to figure out what would probably be the overall best framework when one considers taxes.

 

I live in Denmark where stocks and dividends are taxed at 27-42 percent (when stock is sold/dividend received - losses can be subtracted from future gains indefinately) so I figure I should probably drift towards GARP investing to defer taxes and compound retained earnings instead of trying to flip a lot of net-nets for an example.

 

It's just not really my style as I like cash gushing and out of favor companies that doesn't necessarily have a lot of growth (and sometimes a good bunch of leverage as well) or companies trading close to cash with a free business on top.

 

What do you guys pay in taxes, and how does it affect your investing style? Any thoughts on how you'd approach investing if paying 42 pct. on any capitals gains (holding periode doesn't matter here) would be appreciated as well.

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Taxes are huge and can take a significant chunk away from alpha.  There was a post on here from some user, I forget his username but he completed a CFA, that did some backtest on EV/EBITDA -- I think, can't quite remember the strategy criterion.  I remember that the portfolio was rebalanced all the time whenever a new stock was added or subtracted from the portfolio, and I thought, the returns he found were just too unrealistic.  So, I re-did his calculations and adjusted it for all of the short term capital gains taxes that had to be paid out every year.  It took a sizeable chunk away from returns (over 25%).  Holding even one day longer, for most people, will reduce that down by nearly a half.

 

For my strategies, I don't sell until 366 days unless certain things happen for my sell criteria to kick in.

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With a 42% tax rate, I see 4 options, all with pros and cons:

 

1. Move your residence.

2. Buy something you can hold for a very long time and sell it very rarely.

3. Use any benevolent government programs that protect investment gains, this may include registered accounts or investing through an owned corporation.

4. tax evasion/avoidance of some sort, probably using offshore structures.

 

 

 

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In the US, the federal tax rate on long term capital gains is now 23.8% (20%+an additional 3.8% Obamacare "surcharge"). If you live in  California, you need to pay an additional state tax rate of up to 13%, which brings the combined tax rate on LT capital gains to nearly 37%! If you have short term gains, the combined tax rate is well over 50% in California.

 

I am not sure if people outside California or New York realize this.

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In the US, the federal tax rate on long term capital gains is now 23.8% (20%+an additional 3.8% Obamacare "surcharge"). If you live in  California, you need to pay an additional state tax rate of up to 13%, which brings the combined tax rate on LT capital gains to nearly 37%! If you have short term gains, the combined tax rate is well over 50% in California.

 

I am not sure if people outside California or New York realize this.

 

Please add New Jersey to that list.

 

http://www.fool.com/personal-finance/taxes/2014/10/04/the-states-with-the-highest-capital-gains-tax-rate.aspx

 

 

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I wouldn't call the US a high tax country because the level at which the higher rates kick in are - by global standards and for most individuals - outrageously high. For example, the highest rate for capital gains and income in the States is like $250,000-$400,000 US. Except for a few flat tax countries in Eastern Europe, that sort of rate kicks in at a much lower level everywhere else, in some "first world" nations it kicks in as little as $50,000 US.

 

 

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In the US, the federal tax rate on long term capital gains is now 23.8% (20%+an additional 3.8% Obamacare "surcharge"). If you live in  California, you need to pay an additional state tax rate of up to 13%, which brings the combined tax rate on LT capital gains to nearly 37%! If you have short term gains, the combined tax rate is well over 50% in California.

 

I am not sure if people outside California or New York realize this.

 

As someone else mentioned the thresholds for this are high. $416k of income filing single and $466k filing jointly. There are 892,000 people who pay taxes at this rate. Out of the ~300 million or so citizens it doesn't seem so bad. Now granted a large percentage of that 800k might be on this board, but throwing the number out there to give some perspective.

 

Personally taxes do change how I invest. I invest in domestic stocks and special situations in IRA accounts if I think there is a chance for a short term gain. In my taxable account I buy stocks that will take at least a year to re-rate if not longer. I also look for a greater margin of safety with my taxable stocks because I want to eliminate downside risk. I realized about three years ago that these simple heuristics for my taxable/non-taxable led to my taxable account outperforming. I was more willing to take a flyer in an IRA.  Since then (outside of special sits) I invest my IRA like my taxable account.

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In the US, the federal tax rate on long term capital gains is now 23.8% (20%+an additional 3.8% Obamacare "surcharge").

 

As someone else mentioned the thresholds for this are high. $416k of income filing single and $466k filing jointly. There are 892,000 people who pay taxes at this rate. Out of the ~300 million or so citizens it doesn't seem so bad. Now granted a large percentage of that 800k might be on this board, but throwing the number out there to give some perspective.

 

Obamacare "surcharge" is called Net Investment income tax .

 

Filing Status                          Threshold Amount

Married filing jointly               $250,000

Married filing separately       $125,000

Single                               $200,000

Head of household (with qualifying person) $200,000

Qualifying widow(er) with dependent child $250,000

 

https://www.irs.gov/uac/Newsroom/Net-Investment-Income-Tax-FAQs

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In the US, the federal tax rate on long term capital gains is now 23.8% (20%+an additional 3.8% Obamacare "surcharge").

 

As someone else mentioned the thresholds for this are high. $416k of income filing single and $466k filing jointly. There are 892,000 people who pay taxes at this rate. Out of the ~300 million or so citizens it doesn't seem so bad. Now granted a large percentage of that 800k might be on this board, but throwing the number out there to give some perspective.

 

Obamacare "surcharge" is called Net Investment income tax .

 

Filing Status                          Threshold Amount

Married filing jointly               $250,000

Married filing separately       $125,000

Single                               $200,000

Head of household (with qualifying person) $200,000

Qualifying widow(er) with dependent child $250,000

 

https://www.irs.gov/uac/Newsroom/Net-Investment-Income-Tax-FAQs

 

Interesting, the threshold is still very high unless you live in NYC/LA/SF/DC.

 

This is a really interesting bar chart: http://taxfoundation.org/blog/how-many-taxpayers-fall-each-income-tax-bracket

 

I understand that for most NYC (or California) board members $250k is probably your starting salary and you're getting walloped.  But for the large swath of us outside of the NY it's a salary reserved for doctors and executives.  A friend worked in mortgage origination a few years back, he said at the time there were less than 30 houses in our county assessed for over $1m.  I'm sure the number is higher now, but just putting it into perspective from someone in a "normal" metro area.

 

There are 2.8m taxpayers that pay the Obama surcharge.  Out of 300m people it's less than 1%.  I get that taxes suck if you make a lot of money, and that most on here make a lot of money.  But again it's a very small percentage.  Most taxpayers are in the 15% bracket, where there are no taxes on dividends or capital gains.

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this is the best chart I have found on marginal tax rate for investors and those with ordinary income:

 

https://www.jcfny.org/effective-top-marginal-income-tax-rates/

 

for investors, the best thinking I have found are 2 research reports which go under the name: "is your alpha big enough to cover its taxes?" the newer report also has "revisited" in the title. I recommend them to all taxable investors...

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Personally taxes do change how I invest. I invest in domestic stocks and special situations in IRA accounts if I think there is a chance for a short term gain. In my taxable account I buy stocks that will take at least a year to re-rate if not longer. I also look for a greater margin of safety with my taxable stocks because I want to eliminate downside risk. I realized about three years ago that these simple heuristics for my taxable/non-taxable led to my taxable account outperforming. I was more willing to take a flyer in an IRA.  Since then (outside of special sits) I invest my IRA like my taxable account.

I should probably try to tilt towards that as well since gains in my pension account are taxed 15 pct. whether I realize them or not, so holding short/long term doesn't matter. Still, why is it more import to limit downside risk in your taxable account? Can't you offset future gains with old losses?

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Personally taxes do change how I invest. I invest in domestic stocks and special situations in IRA accounts if I think there is a chance for a short term gain. In my taxable account I buy stocks that will take at least a year to re-rate if not longer. I also look for a greater margin of safety with my taxable stocks because I want to eliminate downside risk. I realized about three years ago that these simple heuristics for my taxable/non-taxable led to my taxable account outperforming. I was more willing to take a flyer in an IRA.  Since then (outside of special sits) I invest my IRA like my taxable account.

I should probably try to tilt towards that as well since gains in my pension account are taxed 15 pct. whether I realize them or not, so holding short/long term doesn't matter. Still, why is it more import to limit downside risk in your taxable account? Can't you offset future gains with old losses?

 

You can offset gains with losses in the current year, but I don't sell often enough.  So that means losses would need to carry-forward, and you can only use $3k of carry-forwards per year.

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this is the best chart I have found on marginal tax rate for investors and those with ordinary income:

 

https://www.jcfny.org/effective-top-marginal-income-tax-rates/

 

for investors, the best thinking I have found are 2 research reports which go under the name: "is your alpha big enough to cover its taxes?" the newer report also has "revisited" in the title. I recommend them to all taxable investors...

 

This is just crazy!  In PA there is a flat tax of 3.07% on all income.  There's also a local earned income tax that's universally 1%, although it's worth noting that dividends, capital gains, and business income (s-corp income) escape this 1% tax.  So the state and local burden is 4% all-in.  It's so much lower than NY/NJ/CT/CA.  I've never looked at those since I've never lived there.  I've had a visceral sense taxes were higher in the major metros, but had never looked to quantify it.

 

Another PA oddity, retirement income is tax-free here.  If you retire in the state and pull from an IRA there's no taxes.

 

I've read stories about people keeping receipts so they can "prove" that they weren't in NYC enough to be taxed NYC rates.  Is this something the taxing authority is keeping track of for everyone or just high profile people?

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Personally taxes do change how I invest. I invest in domestic stocks and special situations in IRA accounts if I think there is a chance for a short term gain. In my taxable account I buy stocks that will take at least a year to re-rate if not longer. I also look for a greater margin of safety with my taxable stocks because I want to eliminate downside risk. I realized about three years ago that these simple heuristics for my taxable/non-taxable led to my taxable account outperforming. I was more willing to take a flyer in an IRA.  Since then (outside of special sits) I invest my IRA like my taxable account.

I should probably try to tilt towards that as well since gains in my pension account are taxed 15 pct. whether I realize them or not, so holding short/long term doesn't matter. Still, why is it more import to limit downside risk in your taxable account? Can't you offset future gains with old losses?

 

You can offset gains with losses in the current year, but I don't sell often enough.  So that means losses would need to carry-forward, and you can only use $3k of carry-forwards per year.

 

I used to be very conscious of taxes and had been very careful to minimize them. Not anymore.

 

I replicate pretty much the same set of investments in both my taxable and non-taxable account. The only change is that in my non-taxable account I try to trade a bit more, buying more on dips and selling on significant run ups. The same set of stocks, produced roughly about 10% more in my non-taxable account compared to taxable over a five year period. So a couple of years back I figured, I might be better off just paying the taxes.

 

Not a whole lot of data, and it might be that my specific set of investments (heavily concentrated in financials) have been volatile and in future might lead to opposite being true. But I think the markets are volatile enough that there is opportunity around trading around a core position that adds to investment returns. Being too focused on taxes might cause one to miss these returns.

 

Vinod

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If you pay 27-42% on gains and you pay nothing on unrealized gains, then hold forever is pretty much the only way to go. There is no way you can generate enough alpha to outweigh losing 27-42% of your gains every time you sell if you sell more often that once in 3 years or so.

 

--------------

Below is my personal US only situation.

 

Fortunately or unfortunately, most of my money is in IRAs/401(k)s, so I get no tax hits from selling.

In taxable account, I haven't sold anything for ages except for stock donations to charities which allow me to get higher bang on the buck for appreciated stock.

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Maybe you can use other people's money. If you have a tax debt of 40% but can borrow at 5%, a 100% gain in your investment will offset some of the higher cost tax. It seems unlikely that tax rates will ever approach the rate of interest, if it does, we are all going very broke :)

 

 

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Interesting to see how others are using their tax free accounts. My lt gains are taxed at 15%, so with that in mind, I'll throw in my two cents:

 

I use my taxable accounts for GARP and speculative positions, as sometimes my losses can help balance out my gains. I started doing this after losing a bit in a position in my IRA, and realizing I couldn't claim the losses. In my IRA, I hold dividend paying stocks (reits and the like), and short term plays (normally mean reversions and event driven stuff).

 

If you find your investment income starts to out-weight your job related income, moving might not be a bad idea as well (as mentioned by others -- that being said, sucks for us Americans with the draconian international taxes). I really enjoyed the book Free Capital (http://www.amazon.com/Free-Capital-private-investors-millions/dp/1906659745), and a few of the investors mentioned have moved to Guernsey, Switzerland, and Hong Kong.

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