Question

In: Finance

Common stock is considered to be one of the most popular investment vehicles for long-term wealth...

Common stock is considered to be one of the most popular investment vehicles for long-term wealth building. Investors earn income from common stock in the form of dividends and/or capital gains. As an investor it is important to understand the implications of investing in stocks from a tax perspective.

Two years ago, David purchased 100 shares of a particular company's stock as a price of $107.69 per share. Last year, David received an annual dividend of $1.50 per share, and at the end of the year, a share of stock was trading at $113.03 per share. This year, David received an annual dividend of $1.65 per share and afterward sold all 100 shares at a price of $123.24 per share.

In the first column of the following table, enter the total annual dividends David received each year, as well as the total capital gains at the end of each year.

Suppose David is in the 28% tax bracket. Compute the taxes David pays each year on dividends and capital gains from this investment by completing the second column in the table.

Calculating taxes owed on David's Investment

Amount Taxes Owed
Year 1 Dividends: ______ ______
Capital Gains: ______ ______
Year 2 Dividends: ______ ______
Capital Gains ______ ______

The total amount of investment income (pre taxes) that David earned on this investment over the course of 2 years is ___________.

The total amount that David pays in taxes on income from this investment income is ________

Solutions

Expert Solution

Answer : No of Shares purchased : 100

Share Price : $ 107.69

At the end of Year 1 :

Dividend received is $1.50 per share

Share price at 113.03, capital gains per share is 113.03 - 107.69 = $5.34

Earnings through dividend is 150 and Earning through share price is $534

At the end of year 2 :

Dividend received is $1.65 per share

Share price at 113.03, capital gains per share is 123.24 - 113.03 = $10.21

Earnings through dividend is 165 and Earning through share price is $1021

The Total Investment income (Pre-taxes) is $1870

Taxes to be paid is $523.6

We have not sold the shares at the end of the 1st year so effective tax at capital gains would be 0 and we would have to pay only dividend tax.

And the net Capital gains effective tax at the end of the second year would be $435 (only capital Gains)

Amount Taxes Owed Effective taxes
Year 1 Dividends 150 42 42
Capital Gains 534 149.52 0
Year 2 Dividends 165 46.2 46.2
Capital Gains 1021 285.88 435

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