Financial Terms related to Tax

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TAX
Ad valorem tax

• Is a tax placed on real property. This is a primary revenue source for many
municipalities.

After tax

• Describes funds on which an employee has already paid all income taxes, for
example, amounts held outside a 401(k) plan or traditional IRA, or within a Roth IRA.
Taxes on benefits derived from these funds, plus investment earnings in a Roth IRA,
are not payable when they are received. See basis. Also known as post-tax.

After tax proceeds from sale of old asset

• Found by subtracting applicable taxes from the proceeds from the sale of an old
asset.

After tax profit margin

• The ratio of net income to net sales.

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After tax real rate of return

• Money after-tax rate of return minus the inflation rate.

• Money after-tax rate of return minus the inflation rate. Hence, this refers to the
purchasing power increase.

Alternative minimum tax

• Abbreviated AMT. An alternative tax computation that adds certain tax preference
items back into Adjusted Gross Income. If the AMT is higher than the regular tax

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liability for the year, then the regular tax and the amount by which the AMT exceeds
the regular tax are paid.

Asymmetric taxes

• A situation wherein participants in a transaction have different net tax rates.

Average pre tax profit margin

• Pre-tax Income divided by Sales. This measures how well management converts
sales dollars into profits after deducting all the operating expenses for making and
selling its products. Compare the last two years' pre-tax profit margins with the 5-
year average to show the trend of growth.

Average tax rate

• Taxes as a fraction of income; total taxes divided by total taxable income.

• A firm's taxes divided by its taxable income.

Before tax

• Describes funds on which the employee has not yet paid income taxes, for
example, amounts held in a qualified plan or traditional IRA. Taxes have been
deferred, not waived, and are normally due when funds are paid out from the
qualified plan or IRA. Also known as pre-tax.

Before tax profit margin

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• The ratio of net income before taxes to net sales.

Break even tax rate

• The tax rate at which a party to a prospective transaction is indifferent between

entering into and not entering into the transaction.

Cash flow after interest and taxes

• Net income plus depreciation.

Corporate tax view

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• The argument that double (corporate and individual) taxation of equity returns
makes debt a cheaper financing method.

Corporate taxable equivalent

• Rate of return required on a par bond to produce the same after-tax yield to
maturity that the premium or discount bond quoted would.

• Rate of return required on a par bond to produce the same after-tax yield to
maturity that the premium or discount bond quoted would.

Deferred income taxes

• On the Balance Sheet, deferred taxes are a liability that result from income already
earned and recognized for accounting purposes, but not for tax purposes.

Deferred taxes

• Are a temporary source of free cash flow. This liability is a non-cash expense until
it is paid.

• A non-cash expense that provides a source of free cash flow. Amount allocated
during the period to cover tax liabilities that have not yet been paid.

Depreciation tax shield

• The value of the tax write-off on depreciation of plant and equipment.

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Double tax agreement

• Agreement between two countries that taxes paid abroad can be offset against
domestic taxes levied on foreign dividends.

Double taxation

• Refers to corporate income which is subject to both corporate taxes and individual
taxes. Frequently, it is viewed as the case whereby the company's income is taxed
and the distribution of that income in the form of a dividend paid to the shareholder
as taxed again.

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• a) A situation where the same income is taxed in two separate countries; to reduce
double taxation, many countries have negotiated tax treaties that override domestic
law; b) Occurs when the already once-taxed earnings of a corporation are distributed
as cash dividends to its shareholders, who are then taxed again on these dividends.

Earnings before interest and taxes

• Abbreviated EBIT. A financial measure defined as revenues less cost of goods sold
and selling, general, and administrative expenses. In other words, operating and
non-operating profit before the deduction of interest and income taxes.

Earnings before interest, taxes, depreciation, and amortization

• Although it is not defined by GAAP, EBITDA can be used to analyze a company's

profitability. Differs from a Cash Flow statement by excluding changes in working
capital and payments for taxes and interest. Calculated by adding Net Income,
income taxes, Interest, Depreciation, and Amortization.

Equivalent taxable yield

• The yield that must be offered on a taxable bond issue to give the same after-tax
yield as a tax-exempt issue.

• The yield on a taxable security that would leave the investor with the same aftertax
return he would earn by holding a tax-exempt municipal; for example, for an investor
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taxed at a 50% marginal rate, equivalent taxable yield on a muni note issued at 3%
would be 6%.

Foreign tax credit

• Home country credit against domestic income tax for foreign taxes paid on foreign
derived earnings.

Imputation tax system

• Arrangement by which investors who receive a dividend also receive a tax credit

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for corporate taxes that the firm has paid.

Income before taxes

• See Pre-tax Income.

Interest equalization tax

• Tax on foreign investment by residents of the U.S. which was abolished in 1974.

Interest tax shield

• The reduction in income taxes that results from the tax-deductibility of interest
payments.

Investment tax credit

• Abbreviated ITC. An incentive for businesses in various regions of the country to

purchase certain types of assets or undertake certain types of research and
development activities; results in a direct reduction of federal taxes that would
otherwise be payable.

• Proportion of new capital investment that can be used to reduce a company's tax
bill (abolished in 1986).

Limited tax general obligation bond

• A general obligation bond that is limited as to revenue sources.

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Marginal tax rate

• The rate at which additional income is taxed.

• The tax rate that would have to be paid on any additional dollars of taxable income
earned.

• The tax rate that would have to be paid on any additional dollars of taxable income
earned.

Mortgage tax

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• Is a tax which is assessed against a new mortgage. It is usually paid by the
borrower.

Net income before taxes

• See Pre-tax Income.

Personal tax view of capital structure

• The argument that the difference in personal tax rates between income from debt
and income from equity eliminates the disadvantage from the double taxation
(corporate and personal) of income from equity.

Pre tax income

• Also may be called Net Income Before Taxes, Income Before Profit, or Income
Before Taxes. This is the profit made by the company before paying taxes. It is
calculated by dividing the net income by one minus the tax rate: Net Income / (1 - tax
rate as a decimal)

Pre tax profit on sales

• Also known as Profit Margin; Profitability. Calculated by dividing the Pre-tax Income
by Net Sales: (Net Income / (1 - Tax Rate)) /Revenues.
This measures the effectiveness of management in controlling expenses and is a
useful measure of overall operational efficiency when compared with prior periods or
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other companies in the same business. This return on sales varies widely between
industries (e.g. 2% return for supermarkets is reasonable, but manufacturing
industries should return 4-5%). A declining profit margin can be caused by declining
sales, declining efficiency, aging plant and equipment, or inappropriate management
decisions. If quarterly pre-tax income is not available, you can estimate the tax rate
from the yearly tax rate.

Progressive tax system

• A tax system wherein the average tax rate increases for some increases in income

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but never decreases with an increase in income.

Regressive tax

• A tax that takes a larger percentage of the income of low-income people than of
high-income people; examples include gasoline tax and cigarette tax. See also:
Progressive Tax.

Short term tax exempts

• Short-term securities issued by states, municipalities, local housing agencies, and

urban renewal agencies.

Split rate tax system

• A tax system that taxes retained earnings at a higher rate than earnings that are
distributed as dividends.

Tabs tax anticipation bills

• Special bills that the Treasury occasionally issues. They mature on corporate
quarterly income tax dates and can be used at face value by corporations to pay
their tax liabilities.

Tans tax anticipation notes

• Tax anticipation notes issued by states or municipalities to finance current

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operations in anticipation of future tax receipts.

Tax anticipation bills

• Abbreviated TABs. Special bills that the Treasury occasionally issues that mature
on corporate quarterly income tax dates and can be used at face value by
corporations to pay their tax liabilities.

Tax anticipation note

• Is a security issued by a municipality against expected tax collections. It has a

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maximum maturity of one year. It is used for cash management purposes.

Tax basis

• See Basis.

Tax books

• Set of books kept by a firm's management for the IRS that follows IRS rules. The
stockholder's books follow Financial Accounting Standards Board rules.

Tax breaks

• One form of government incentive used to encourage corporate capital

expenditures involving the tax savings associated with being able to claim non-cash
expenses like amortization (CCA). The CCA rate can be increased by Order-in-
Council in order to increase the tax shield benefits available to companies.

Tax clawback agreement

• An agreement to contribute as equity to a project the value of all previously realized

project-related tax benefits not already clawed back to the extent required to cover
any cash deficiency of the project.

Tax deferral

• The postponement of taxes on the earnings or growth related to certain favored

investments until the earnings are withdrawn.
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Tax deferral option

• The feature of the U.S. Internal Revenue Code that the capital gains tax on an
asset is payable only when the gain is realized by selling the asset.

Tax deferred

• Refers to a situation or an investment whereby the tax liability is delayed until a

later date. Retirement plans such as 401K and IRAs are examples of this feature.

Tax deferred retirement plans

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• Employer-sponsored and other plans that allow contributions and earnings to be
made and accumulate tax-free until they are paid out as benefits.

Tax differential view of dividend policy

• The view that shareholders prefer capital gains over dividends, and hence low
payout ratios, because capital gains are effectively taxed at lower rates than
dividends.

Tax efficient portfolios

• Are investment holdings which have both trading profits and tax minimization
impact as goals. These portfolios recognize that the subsequent payment of taxes
reduces the investor's after tax returns. When holdings are held by pension plans or
tax deferred accounts, there is no immediate tax liability on realized gains. However,
an investor holding mutual funds which have high rates of security turnover and
significant realized gains are subject to immediate tax year liabilities.

Tax exempt

• Refers to income or property which is not subject to tax. Interest on Municipal bond
is not subject to federal income tax. Similarly, interest on a treasury bond is not
subject to state or local income taxes.

Tax exempt sector

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• The municipal bond market where state and local governments raise funds. Bonds
issued in this sector are exempt from federal income taxes.

Tax free acquisition

• A merger or consolidation in which 1) the acquirer's tax basis in each asset whose
ownership is transferred in the transaction is generally the same as the acquiree's,
and 2) each seller who receives only stock does not have to pay any tax on the gain
he realizes until the shares are sold.

Tax haven

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• A nation with a moderate level of taxation and/or liberal tax incentives for
undertaking specific activities such as exporting or investing.

Tax reform act of 1986

• A 1986 law involving a major overhaul of the U.S. tax code.

Tax shield

• The reduction in income taxes that result from taking an allowable deduction from
taxable income.

Tax swap

• Swapping two similar bonds to receive a tax benefit.

Tax timing option

• The option to sell an asset and claim a loss for tax purposes or not to sell the asset
and defer the capital gains tax.

Taxable acquisition

• A merger or consolidation that is not a tax-fee acquisition. The selling shareholders

are treated as having sold their shares.

Taxable capital gain

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• The percentage of net capital gains (the difference between capital gains and
capital losses) that are included as taxable income, currently 50 percent.

Taxable gain

• The portion of a sale of a security or distribution of Mutual Fund shares that is

subject to taxation.

Taxable income

• Gross income less a set of deductions.

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Taxable transaction

• Any transaction that is not tax-free to the parties involved, such as a taxable
acquisition.

Two tier tax system

• A method of taxation in which the income going to shareholders is taxed twice.

Value added tax

• Method of indirect taxation whereby a tax is levied at each stage of production on

the value added at that specific stage.

Withholding tax

• A tax levied by a country of source on income paid, usually on dividends remitted

to the home country of the firm operating in a foreign country. Tax levied on
dividends paid abroad.