The This post is to help increase your understanding of how the cost basis fields are used in Moneytree Advise. The cost basis input is found on the Rates section and is available for taxable assets and annuity assets. Moneytree Advise does not account for non-deductible retirement account deposits, so the balances are assumed to have a 100% cost basis.
The costs basis set in the rates section is tracked to determine what portion of the current asset value entered in the Asset section would be subject to capital gains tax upon withdrawal.
- If you set the cost basis of 100%, the program will not tax any withdrawal from principal.
- If you set the cost basis as 0%, the withdrawal from principal is taxed at the capital gains rate.
- Current asset value (as entered in the asset input – aka the “principal value”) = $100,000
- Original value of asset upon purchase = $80,000
- Cost basis percentage = 80,000/100,000 = 80%
This means 20% of the current asset value is due to appreciation, and still untaxed. If you have a stock that has appreciated 20% since you purchased it, that 20% has not yet been taxed, and will be subject to capital gains tax when you sell the stock. This is the amount that will be subject to capital gains upon withdrawal.
The program tracks cost basis annuity assets, because withdrawals from retirement accounts are assumed to be 100% taxable, and tax free account withdrawals are not taxed.
Every year the program keeps track of the cost basis ratio to determine what portion of the withdrawal is subject to taxes. Whenever the clients must use funds to cover their expenses, they must pay taxes on the withdrawal.
For annuity assets, the program withdraws from the untaxed appreciation before the cost basis. The Tax Deferred Annuities report tracks the cumulative untaxed growth. Once cumulative growth reaches $0, it taxes the annual growth and uses the growth to cover part of the shortage. The rest of the shortage comes from the cost basis. Additions to annuities go towards the cost basis and do not affect the cumulative growth.
With savings and investments, the program withdraws funds such that a portion undergoes taxes. The program uses special capital gains tax rates. The exact portion subject to taxation is proportional to the cost basis. For example if for a cost basis percentage of 80%, 80% of a withdrawal comes from the cost basis. It taxes the remaining 20% at the capital gains rate. In years where there are additions, the program adjusts the cost basis percentage. No reports show the cumulative growth or cost basis. The program keeps track of the cost basis percentage through background calculations.
Savings & Investment Account Example:
Let’s say a withdrawal from the $100,000 dollar account occurs year 1 of $15,000. We will assume that the after-tax growth on the account is $5,000. We will use an ordinary income tax rate of 20%.
- The program first uses the after-tax growth towards the shortage, so the amount that comes from the principal is $10,000 ($15,000 – $5,000)
- Because the cost basis is 80%, that means 20% of the principal withdrawal will be subject to capital gains.
- $10,000 * 20% = $2,000 principle withdrawal subject to capital gains tax.
- $2,000 x 15% capital gains rate = $300 capital gains tax due on the principal withdrawal.
- However, for each tax dollar, that is another dollar that must be withdrawn from principal. The assumption continues that 20% of the withdrawal comes from untaxed appreciation.
- This formula calculates the total tax on withdrawal from principal:
- Tax on Withdrawal = ($2,000 * 15%) / (1 – 15% * 20%) = $309
Because funds withdrawals proportionally, the cost basis ratio remains unchanged in years where the investment account balance decreases. The ratio changes whenever the balance on savings and investments accounts increases. This is because the the program taxes the calculated growth and additions are after tax. Consider a similar example above, with a $100,000 investment account. But this time there is a $15,000 addition and the same $5,000 after tax growth.
- Original Values:
- Cost Basis Percentage: 80%.
- Balance: $100,000.
- Cost Basis: $80,000.
- Total Addition to the Asset: $15,000 addition + $5,000 after-tax growth = $20,000.
- New Values:
- Cost Basis: $80,000 + $20,000 = $100,000.
- Balance: $100,000 + $20,000 = $120,000.
- Cost Basis Percentage: $100,000 / $120,000 = 83.33%.