72 Part 2 Fundamental Concepts in Financial Management
the 15% maximum rate is scheduled to increase to 20% after 2010. That’s still better
than 35%, though; so from a tax standpoint, capital gains income is good.
Dividends received by individuals in 2008 are also taxed at the same 15% rate
as long-term capital gains. However, the rate is scheduled to rise after 2010. Note
that since corporations pay dividends out of earnings that have already been taxed,
there is double taxation of corporate income—income is! rst taxed at the corporate
rate; and when what is left is paid out as dividends, it is taxed again. This double
taxation motivated Congress to reduce the tax rate on dividends.
Tax rates on dividends and capital gains have varied over time, but they have
generally been lower than rates on ordinary income. Congress wants the economy
to grow. For growth, we need investment in productive assets; and low capital
gains and dividend tax rates encourage investment. Individuals with money to
invest understand the tax advantages associated with making equity investments
in newly formed companies versus buying bonds, so new ventures have an easier
time attracting capital under the tax system. All in all, lower capital gains and divi-
dend tax rates stimulate capital formation and investment.
One other tax feature should be addressed—the Alternative Minimum Tax
(AMT). The AMT was created in 1969 because Congress learned that 155 million-
aires with high incomes paid no taxes because they had so many tax shelters from
items such as depreciation on real estate and municipal bond interest. Under the
AMT law, people must calculate their tax under the “regular” system and then under
the AMT system, where many deductions are added back to income and then taxed
at a special AMT rate. The law was not indexed for in" ation; and by 2007, literally
millions of taxpayers’ found themselves subject to this very complex tax.^163-7b Corporate Taxes
The corporate tax structure, shown in Table 3-6, is relatively simple. To illustrate,
if a! rm had $65,000 of taxable income, its tax bill would be $11,250.Taxes! $7,500 " 0.25($15,000)
! $7,500 " $3,750! $11,250Its average tax rate would be $11,250/$65,000! 17.3%. Note that corporate income
above $18,333,333 has an average and marginal tax rate of 35%.Interest and Dividends Received by a Corporation
Corporations earn most of their income from operations, but they may also own
securities—bonds and stocks—and receive interest and dividend income. InterestAlternative Minimum
Tax (AMT)
Created by Congress to
make it more difficult for
wealthy individuals to
avoid paying taxes
through the use of various
deductions.Alternative Minimum
Tax (AMT)
Created by Congress to
make it more difficult for
wealthy individuals to
avoid paying taxes
through the use of various
deductions.(^16) On December 26, 2007, President Bush signed legislation that (1) increases the AMT exemption amounts for
2007 to $44,350 for single taxpayers and $66,250 for joint! lers and (2) allows taxpayers to take several tax credits
for AMT purposes through 2007.
If a Corporation’s
Taxable Income Is
It Pays This
Amount on the
Base of the Bracket
Plus This Percentage
on the Excess over the
Base (Marginal Rate)
Average Tax
Rate at Top of
Bracket
Up to $50,000 $ 0 15% 15.0%
$50,000–$75,000 7,500 25 18.3
$75,000–$100,000 13,750 34 22.3
$100,000–$335,000 22,250 39 34.0
$335,000–$10,000,000 113,900 34 34.0
$10,000,000–$15,000,000 3,400,000 35 34.3
$15,000,000–$18,333,333 5,150,000 38 35.0
Over $18,333,333 6,416,667 35 35.0
Tabl e 3 - 6 Corporate Tax Rates as of January 2008