Tax Drag

DEFINITION of 'Tax Drag'

The reduction of potential income due to taxes. Drag describes the loss in returns owing to taxation, usually on an investment. Tax drag is commonly used when describing the difference between an investment vehicle that is tax-sheltered and one that is not. For many individuals, tax drag can have a significant effect on overall investment performance.

BREAKING DOWN 'Tax Drag'

Tax-efficient investing techniques are very important for recognizing capital gains, transferring wealth and estate planning.

For example, suppose that an individual can invest $1 million in two securities in either Country A (with a 25% withholding tax) or Country B (with a 15% withholding tax). Both securities pay a 2.5% dividend. Security A would return $25,000 minus $6,250 in taxes, for a total of $18,750. Investment B would return $25,000 minus $3,750 in taxes, for a total of $21,250. Therefore, returns would be 1.875% for Security A and 2.125% for Security B, equating to a tax drag of 25 basis points (the difference in returns between the two securities).

RELATED TERMS
  1. Taxes

    An involuntary fee levied on corporations or individuals that ...
  2. Income Tax

    A tax that governments impose on financial income generated by ...
  3. Earnings Before Tax - EBT

    An indicator of a company's financial performance calculated ...
  4. Tax Liability

    The total amount of tax that an entity is legally obligated to ...
  5. Capital Gains Tax

    A type of tax levied on capital gains incurred by individuals ...
  6. Tax Gain/Loss Harvesting

    Selling securities at a loss to offset a capital gains tax liability. ...
Related Articles
  1. Taxes

    Tax Treatment Of Roth IRA Distributions

    Learn the requirements for withdrawing funds tax and penalty free.
  2. Retirement

    Tax Tips For The Individual Investor

    We give you seven guidelines to help you keep more of your money in your pocket.
  3. Taxes

    Tax-Efficient Wealth Transfer

    Taxpayers with large taxable estates were required to take steps to reduce them before 2011.
  4. Taxes

    Minimize Taxes With Asset Location

    Learn how to maximize your investment returns with this tax-minimization strategy.
  5. Taxes

    Taxation Rules For Bond Investors

    Several factors affect the taxable interest that must be reported. Learn more here.
  6. Retirement

    When a 401(k) Hardship Withdrawal Makes Sense

    If you've exhausted all other avenues, there are ways to withdraw funds before age 59½ – sometimes without the 10% penalty that's usually due.
  7. Taxes

    What All the Candidates’ Tax Plans Are Missing

    The presidential candidates have starkly different tax-reform proposals – but none of them gets to the real problem of America's tax system.
  8. Tax Strategy

    Assets the Ultra-Rich Use to Reduce (or Avoid) Taxes

    Paintings, oil wells and yachts can get great tax write-offs for their wealthy owners. All it takes is some smart gaming of the tax code.
  9. Your Clients

    Panama Papers: What Advisors Need to Know

    Here is how clients may be impacted by some of the issues brought to light by the Panama Papers.
  10. Taxes

    Can't Pay Your Taxes? What to Do Now

    Not enough cash on hand for your April tax bill? No need to panic. Here's what to do.
RELATED FAQS
  1. What are common advantages of investing in large cap stocks?

    Learn what large-cap stocks are and how investors can benefit from common advantages of adding large-cap stocks to their ... Read Answer >>
  2. Are credit card rewards considered taxable income by the IRS?

    Learn about when the Internal Revenue Service considers the financial value of gifts received from credit card reward programs ... Read Answer >>
  3. What is the difference between a REIT and a master limited partnership

    While both are prized for their dividends by income investors, there are notable differences between REITs and master limited ... Read Answer >>
  4. How long do I need to keep income tax records?

    Learn how long you need to save your tax records to avoid getting hit by additional taxes and penalties if you are the target ... Read Answer >>
  5. Can a spouse who is not named as a beneficiary receive assets from an IRA?

    It depends.Generally speaking, the designation of beneficiary form dictates who receives the assets from the individual retirement ... Read Answer >>
  6. What are the Best Ways to Lower My Taxable Income?

    Paying taxes is an unavoidable obligation each year, but individuals and business owners can take advantage of various strategies ... Read Answer >>
Hot Definitions
  1. Yield Curve

    A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity ...
  2. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  3. Society for Worldwide Interbank Financial Telecommunications ...

    A member-owned cooperative that provides safe and secure financial transactions for its members. Established in 1973, the ...
  4. Generally Accepted Accounting Principles - GAAP

    The common set of accounting principles, standards and procedures that companies use to compile their financial statements. ...
  5. DuPont Analysis

    A method of performance measurement that was started by the DuPont Corporation in the 1920s. With this method, assets are ...
  6. Call Option

    An agreement that gives an investor the right (but not the obligation) to buy a stock, bond, commodity, or other instrument ...
Trading Center