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Exam Three Note Sheets Chapters 11-14

Exam Three Note Sheets Chapters 11-14 - Chapter 11...

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Chapter 11 – Investments Overview: Two key characteristics that affect after tax returns from investments are 1) the timing of tax payments or benefits and 2) the rate at which the investment income or gains are taxed or deductible expenses and losses generate tax savings. Portfolio Income: portfolio investments (investments producing dividends, interest, royalties, annuities, or capital gains) may be taxed at ordinary rates, preferential rates, or may be exempt from taxation. *Interest Income: taxpayers recognize interest income from investments when they receive the interest payments. Investments in savings accounts, money market accounts, CDs and most bonds receive interest payments based on a stated annual rate or return at a stated interval. Formulas for the After-Tax Rate of Return and the After-Tax Future Value of Investment with Constant Rate of Return Annual after-tax rate of return= before tax rate of return x (1-marginal rate) After tax future value = I x (1+r)^n, where I = original amount invested, r = the annual after tax rate of return, and n = number of years maintained. *Corporate and US Treasury Bonds: Two primary differences between holding corporate or Treasury bonds: 1) interest from Treasury bonds is exempt from state taxation while interest from corporate bonds is not and 2) Treasury bonds always pay interest periodically while corporate bonds may or may not. Tax rules for determining the timing and amount of interest income from corporate and Treasury bonds: *Taxpayers include the actual interest payments they receive in gross income. *If issued at discount, special original issue discount (OID) rules apply; taxpayers are required to amortize the discount and include the amount of the current year’s amortization in gross income in addition to any interest payments actually received. In the case of corporate zero-coupon bonds, the taxpayers must report and pay taxes on income related to the bonds even though they did not receive any payments from the bonds. Issuers or brokers calculate the yearly amortization and provide it to investors through Form 1099-OID. *If issued at premium, taxpayers may elect to amortize the premium; taxpayers or their advisors determine the amortization of the premium if elected to amortize. The amount of the current year offsets a portion of the actual interest payments that taxpayers must include in gross income. The original tax basis of the bonds includes the premium and is reduced by any amortization of bond premium over the life of the bond. *If the bond is purchased in the secondary bond market at a discount, the taxpayer treats some or all of the market discount as interest income when she sells the bond or it matures. If sold prior to maturity, a ratable amount of the market discount based on the number of days the bond is held over the number of days until maturity when the bond is purchased called the accrued market discount, is treated as interest income on the date of the sale.
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