After-Tax Basis (Bonds) - Explained
What is After-Tax Basis for Bond?
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Table of ContentsWhat is the after-tax basis of bonds?How is the After-Tax Basis of Bonds Used? Considerations Besides After-Tax CostsAcademics Research on After-Tax Basis
What is the after-tax basis of bonds?
The basis (cost basis) of an investment is the principal amount paid on the investment. The after-tax basis is used for taxable bonds to calculate the return on the investment by deducting the taxes paid on the bond from the yield of the bond. The after-tax basis also refers to how a comparison is made between the net yields of taxable bonds and tax-exempt bonds.
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How is the After-Tax Basis of Bonds Used?
Usually, investors are interested in comparing the return on investment otherwise called yields of two different investment instruments. Taxable bonds, for instance, may offer higher returns than tax-exempt bonds, through the after-tax basis, investors can accurately compare the yields of these two products. This comparison is done by subtracting the taxes paid on bonds from the yield. Finding out the after-tax basis of a bond might be a little technical, this is why many investors seek the help of a tax expert in order to know the exact amount to be paid as tax on a particular investment. Different investment instruments also attract different taxes which is based on their earnings.
Considerations Besides After-Tax Costs
A corporate bond is a taxable bond when the after-tax basis of this bond is calculated, it helps to determine how profitable the bond is as compared to other tax-exempt bonds. When measuring the profitability of a bond, it is not sufficient to use just the after-tax basis, there are other factors that must be put into consideration such as the risks of the investment. Tax experts and financial professionals provide the needed assistance to investors when measuring the profitability of investments to know which is better.
Academics Research on After-Tax Basis
- Ranking mutual funds on an after-tax basis, Dickson, J. M., & Shoven, J. B. (1993). Ranking mutual funds on an after-tax basis (No. w4393). National Bureau of Economic Research.
- Do after-tax returns affect mutual fund inflows?, Bergstresser, D., & Poterba, J. (2002). Do after-tax returns affect mutual fund inflows?. Journal of Financial Economics, 63(3), 381-414. This paper explores the relationship between the after-tax returns that taxable investors earn on equity mutual funds and the subsequent cash inflows to these funds. Previous studies have documented that funds with high pretax returns attract greater inflows. This paper presents evidence, based on a large sample of retail equity mutual funds over the period 19931999, that after-tax returns have more explanatory power than pretax returns in explaining inflows. In addition, funds with large overhangs of unrealized capital gains experience smaller inflows, all else equal, than funds without such unrealized gains. A large capital gain overhang discourages both gross fund inflows and gross outflows, but the inflow effect dominates the outflow effect.
- CEO aftertax compensation incentives and corporate tax avoidance, Gaertner, F. B. (2014). CEO aftertax compensation incentives and corporate tax avoidance. Contemporary Accounting Research, 31(4), 1077-1102. I examine the association between CEOs after-tax incentives and their firms level of tax avoidance. Economic theory holds that firms should compensate CEOs on an after-tax basis when the expected tax savings generated from additional incentive alignment outweigh the incremental compensation demanded by CEOs for bearing additional tax-related compensation risk. Using hand-collected data from proxy statements, I find a negative relation between the use of after-tax incentives and effective tax rates. I also find a positive association between the use of after-tax incentives and CEO cash compensation, suggesting that CEOs who are compensated on an after-tax basis demand a premium for bearing additional risk.
- Valuing the deferred tax liability, Sansing, R. (1998). Valuing the deferred tax liability. Journal of Accounting Research, 36(2), 357-363. Using a model of corporate investment in which the deferred tax liability never reverses, I show that deferred taxes are a real economic burden whose value is the amount recognized multiplied by a fraction. The numerator of the fraction is the tax depreciation rate, and the denominator of the fraction is the sum of the tax depreciation rate and the cost of capital. Intuitively, even though the deferred tax liability never reverses, the difference between tax and book depreciation decreases over time because the tax bases of the assets gradually diverge from their book value.
- Explaining after-tax mutual fund performance, Peterson, J. D., Pietranico, P. A., Riepe, M. W., & Xu, F. (2002). Explaining after-tax mutual fund performance. Financial Analysts Journal, 58(1), 75-86. Published research on the topic of mutual fund performance focuses almost exclusively on pretax returns. For U.S. mutual fund investors holding positions in taxable accounts, however, what matters is the after-tax performance of their portfolios. We analyzed after-tax returns on a large sample of diversified U.S. equity mutual funds for the 198198 period. We found the variables that determined after-tax performance for this period to be past pretax performance, expenses, risk, style, past tax efficiency, and the recent occurrence of large net redemptions.