How to Calculate the Tax Cost of Common Equity

When you sell your equity at a higher price than its purchase price, the difference is a capital gain.

When you invest in a company, you buy shares of its common equity. This equity makes you a partial owner of the company and entitles you to a share of its profits. Equity pays you a return on your investment in dividends and capital gains. Dividends are a payout of annual profits to all shareholders. Capital gains are the profits you make by selling your stock shares at a higher price than you paid for them. The total tax cost of common equity is the sum of taxes on dividends and capital gains. Dividends are taxed as income. Capital gains are taxed as income if you own the equity for less than one year and at lower capital gains rates if you own the equity over a year.

Instructions

1. Review your investment statement to see if your company has declared an annual dividend. If it has, record your total dividend payout for the year.

2. Multiply your annual dividend by your income tax rate to calculate your dividend tax cost.

3. Look through your stock records to find the initial purchase price of your equity and its price on the day you sold your shares.

4. Subtract the purchase price from the sale price of your equity. The increase is your capital gain per share. Multiply the gain per share by the total number of shares to calculate your total capital gain.

5. Multiply your total capital gains by the appropriate capital gains rate to calculate your capital gains tax due. As of 2011, the long-term gains rate is 15 percent if you are in a 25 percent income tax bracket or higher. There is no capital gains tax due if you are in the 10 or 15 percent income tax bracket.

6. Add your capital gains taxes and dividend taxes to find your tax cost of common equity.

Tips & Warnings

• Be sure to distinguish between a short-term and long-term capital gain. If you owned the stock less than one year, it is a short-term gain and must be multiplied by your income tax rate. If you owned the stock over a year, it is a long-term gain.

References

• "Fundamentals of Income Taxation"; James Ivers III, et al.; 2010
• "Fundamentals of Investments for Financial Planning"; Walt J. Woerheide; 2008