Breakeven Tax Rate

What is the Breakeven Tax Rate

Breakeven tax rate is a tax rate above what is not profitable to engage in a transaction. In other words, the breakeven tax rate is the rate at which it would neither be advantageous or disadvantageous for a company to conduct a certain transaction. A breakeven tax rate allows people to examine the transaction rather than tax incentives.

BREAKING DOWN Breakeven Tax Rate

Breakeven tax rate is not a set numerical rate, like the Social Security tax rate. The breakeven tax rate in and of itself is essentially a conceptual threshold. When taxes rise above the breakeven rate, there would not be enough profit or financial benefit for the parties involved to justify the time and effort required to transact business. Therefore, anything below this rate would give investors or other parties incentive to engage in a transaction, whereas a rate above the breakeven tax rate would not.

A tax rate is the ratio, usually expressed in a percentage, at which a person or business is taxed. There are several methods used to present a tax rate such as statutory, average, marginal and effective. These rates can also be presented using different definitions applied to a tax base. A statutory tax rate is the legally imposed rate. An average tax rate is the ratio of the total amount of taxes paid to the tax base and a marginal tax rate is the tax rate an individual would pay on one additional dollar of income.

An Example of Breakeven Tax Rate

Say investor A owns 1,000 shares of stock in ABC Company, and the price starts to decline. He originally paid $25 per share for the entire lot, and the stock is now trading at about $100 per share. However, a major financial crisis has hit the company and the share price is starting to fall rapidly. The investor has held the shares for nearly a year, which means that the investor can either sell them now and pay tax on the gain as ordinary income, or wait for the one-year holding period date and then sell and pay tax at the lower capital gains rate. But of course, paying a higher rate on stock sold at $75 per share is probably better than waiting for the stock to fall to $50 per share and then paying a lower rate on less gain. The movement of the stock price will ultimately determine which path is better, but there will be a stock price at which the investor will come out the same regardless of whether they report a short- or long-term gain.

Article Sources
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  1. Internal Revenue Service. "IRS Provides Tax Inflation Adjustments for Tax Year 2020." Accessed Oct. 24, 2020.

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