Decision model and analysis for investment interest expense deduction and allocation

TY - JOUR

T1 - Decision model and analysis for investment interest expense deduction and allocation

AU - Lee, Zu Hsu

AU - Deng, Shiming

AU - Lin, Beixin

AU - Yang, James G.S.

PY - 2010/1/1

Y1 - 2010/1/1

N2 - Investment income tax planning requires informed, strategic choices. One must determine the amount of qualified dividends and net long-term capital gain to be included in investment income (against which investment interest expense can be deducted). This choice also determines the residual qualified dividends and net long-term capital gain which enjoy a reduced tax rate. Another important decision is whether all or some of this interest expense should be deducted in the current year or carried forward. This paper puts forward a new approach to formulate these questions as a generalized resource allocation problem which permits analysis of the interdependence between, and the tax consequences of, the above decisions. The commonly used approach - deducting investment interest expense sooner rather than later - we consider myopic since the benefit of deferring some of the deduction is not leveraged. Presented here is a tax planning guideline (a necessary and sufficient condition for optimality) to realize a more forward-looking strategy. We also show that, for certain income structures, the tax savings by deducting a one-dollar investment interest expense may be more than the tax rate on the dollar of investment income that is offset.

AB - Investment income tax planning requires informed, strategic choices. One must determine the amount of qualified dividends and net long-term capital gain to be included in investment income (against which investment interest expense can be deducted). This choice also determines the residual qualified dividends and net long-term capital gain which enjoy a reduced tax rate. Another important decision is whether all or some of this interest expense should be deducted in the current year or carried forward. This paper puts forward a new approach to formulate these questions as a generalized resource allocation problem which permits analysis of the interdependence between, and the tax consequences of, the above decisions. The commonly used approach - deducting investment interest expense sooner rather than later - we consider myopic since the benefit of deferring some of the deduction is not leveraged. Presented here is a tax planning guideline (a necessary and sufficient condition for optimality) to realize a more forward-looking strategy. We also show that, for certain income structures, the tax savings by deducting a one-dollar investment interest expense may be more than the tax rate on the dollar of investment income that is offset.

KW - Income tax

KW - Investment interest expense

KW - Linear programming

KW - Nonlinear programming

KW - OR in strategic planning

UR - http://www.scopus.com/inward/record.url?scp=69249236979&partnerID=8YFLogxK

U2 - https://doi.org/10.1016/j.ejor.2008.12.012

DO - https://doi.org/10.1016/j.ejor.2008.12.012

M3 - Article

SN - 0377-2217

VL - 200

SP - 268

EP - 280

JO - European Journal of Operational Research

JF - European Journal of Operational Research

IS - 1

ER -