Portfolio Management and Wealth Planning【Reading 11】 ordinary, following, income

kim226

Which of the following has favorable tax treatment under a “flat and heavy” tax regime?

A) Capital gains.

B) Dividend income.

C) Interest income.

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The tax on ordinary income is flat and there is not a favorable tax treatment for dividend income and capital gain income. Interest income has a favorable treatment.

karoliukas

On a graph where the risk is on the horizontal axis and the returns are on the vertical axis, the existence of taxes on investment returns would probably shift the mean-variance optimization portfolio:

A) down and to the left.

B) down and to the right.

C) down only, and there would not be a shift left or right.

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Taxes lower returns, but they also shift some of the investment risk to the government.

karoliukas

When highest-in-first-out (HIFO) accounting is allowed, it is advisable for:

A) an investor to liquidate the portion of a position with the lowest cost basis first, thereby minimizing current taxes.

B) an investor to liquidate the portion of a position with the highest cost basis first, thereby minimizing future taxes.

C) an investor to liquidate the portion of a position with the highest cost basis first, thereby minimizing current taxes.

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If an investor has accumulated a security position through a series of trades each occurring at different points in time and at different prices and if HIFO accounting is allowed by the government, the investor can liquidate the portion of a position with the highest cost basis first. This minimizes current taxes. As with tax loss harvesting, the total taxes over time are unchanged with HIFO accounting.

karoliukas

The main benefit of tax-loss harvesting is:

A) saving on current taxes.

B) saving on future taxes.

C) reducing both current and future taxes.

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Although tax loss harvesting saves on current taxes, the apparent tax savings in a given year are misleading. This is because when the security is sold and the proceeds are reinvested, the cost basis of the new, replacement security is the low sales price of the old security. In other words, when the old security is sold, the cost basis for future taxes is reduced, thereby resulting in higher taxes in the future.

karoliukas

Chris Manning, CFA is advising a client concerning harvesting tax losses. The client expects that her tax situation will not change over the next few years. She asks about incurring a given loss in the current year or waiting a few years to incur the loss. She asks how the decision will affect the total taxes she pays over her life. Manning should advise her that:

A) she should not incur the loss this year because the HIFO principle means her total taxes will be higher if she incurs the loss this year.

B) she should incur the loss this year because the HIFO principle means her total taxes will be lower if she does.

C) the total tax bill over her life will not change if her tax status does not change.

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Under the indicated conditions, i.e., the tax rate not changing in the foreseeable future, the total tax burden will be the same. It is better to take losses early only to reap the gains earlier and be able to invest the gains earlier.

karoliukas

Of traders, active investors, and passive investors, which probably forgo the most tax advantages of equity?

A) Active investors.

B) Passive investors.

C) Traders.

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Traders trade the most frequently, and would forgo the tax-deferred properties of equity that is allowed to grow in value over a long period. Active investors trade less frequently than traders.

karoliukas

With respect to traders and active investors, which of the following statements is the most accurate?

A) Active investors trade more frequently than traders so that many of their gains are taxed at lower rates.

B) Active investors trade as frequently as traders but they use strategies that lead to their gains being taxed at higher rates.

C) Active investors trade less frequently than traders so that many of their gains are taxed at lower rates.

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Traders trade more frequently. Therefore, traders generally pay higher tax rates.

karoliukas

With respect to active investors and the tax structure in many countries, which of the following is the most accurate?

A) To offset their higher taxation, active investment managers must generate higher pre-tax returns.

B) To offset their higher taxation, active investment managers must use tax-exempt accounts.

C) As a result of their lower taxation, active investment managers can remain in business even when they generate lower pre-tax returns.

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To offset their higher taxation, active investment managers must generate higher pre-tax returns. This is also true for mutual funds, especially those with high turnover, because in many countries, long-term capital gains are taxed at a lower rate and accumulate tax-free until the gains are realized.

karoliukas

Gil Tabor, CFA and Jan Sills, CFA are discussing how the choice of account type affects investment risk and the amount of that risk borne by the government via taxes. Tabor says that the government bears some of the tax risk in a tax-exempt account. Sills says the government bears some of the risk in a tax-deferred account. With respect to these assertions:

A) both Tabor and Sills are incorrect.

B) both Tabor and Sills are correct.

C) Tabor is correct and Sills is incorrect.

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If the investment is held in a tax-exempt account, then the investor bears all the investment risk. This is also true for tax-deferred accounts because even though the government taxes the future accumulation, the variability of returns is not reduced by taxes levied at the time of withdrawal.

karoliukas

Which of the following moves by a government would most likely lead to the government taking on more investment risk?

A) Moving from a heavy dividend tax regime to a common progressive tax regime.

B) Tax regimes cannot shift investment risk.

C) Moving from a common progressive tax regime to a heavy dividend tax regime.

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Moving from a common progressive tax regime to a heavy dividend tax regime would increase the tax on dividends, which are taxed annually, and this would shift some of the investment risk to the government.