 # Tax Calculation first or Inflation calculation first?

When it come to calculating the required rate of return for an individual, do we consider tax first or inflation first? Example: Require 6% after tax return. 28% tax rate 3% inflation. What is the before-tax required rate of return? Tax consideration first: 6/0.72=8.33 8.33+3=11.33% This is the before tax required rate of return. Inflation consideration first: 6+3=9 9/0.72=12.5% This is the before tax required rate of return. Which method? Thanks

ws, Taxes are collected on nominal gains (and not real gains). You need to get the nominal return first then calculate the taxes due.

Good point…didn’t even think like that. Thanks.

Though I fully agree with mo34, I think Reading 15 in the CFAI book #2 is sometimes confusing about whether inflation or tax comes first. In the same vein, I am puzzled by the sentence p. 190 “In modelling asset allocation scenarios, the advisor must address the question of whether to use of after-tax return assumptions for individual asset classes or to instead use pretax assumptions and apply taxes to the resulting investment outcomes”. Am I wrong to believe that the latter is correct, as there might be tax trade-offs between various assets?

I would think that that you first define or given in the problem whether the 6% required return is before or after tax and I think it makes more sense to work from inflation adjusted before tax return and the factor the tax later…i guess in short answer to your question, if 6% is after tax return, then before tax return would be 6%/0.72=8.33% and before tax, before inflation real return is 5.33%…makes sense

its 6+3=9 … the 9/0.72… thats the correct way

agree. mo34 Wrote: ------------------------------------------------------- > ws, > > Taxes are collected on nominal gains (and not > real gains). You need to get the nominal return > first then calculate the taxes due.