Author Topic: A concise way to explain the tax treatment of LC?  (Read 9107 times)

Xin

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A concise way to explain the tax treatment of LC?
« on: October 20, 2013, 08:01:42 PM »
I stumble when I try to explain the tax situation of LC to friends. I know it's tax-inefficient- even worse than corporate bonds. But basically all I come up with is "it's like they tax you on your revenue rather than profit".

Does anybody have a better way to put it?

Grant

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Re: A concise way to explain the tax treatment of LC?
« Reply #1 on: October 20, 2013, 08:37:17 PM »
The interest is treated like any other interest, for the most part. 

Note sales are treated like any other traded security... Long and short term capital gains and losses.

It's only inefficient in as much as interest is taxed at your marginal tax rate vs capital gains rates.

Xin

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Re: A concise way to explain the tax treatment of LC?
« Reply #2 on: October 21, 2013, 03:14:38 AM »
The interest is treated like any other interest, for the most part. 

Note sales are treated like any other traded security... Long and short term capital gains and losses.

It's only inefficient in as much as interest is taxed at your marginal tax rate vs capital gains rates.

A comment thread on Peter's blog w/ "SoCalLender" mentioned something about how defaults were treated as capital losses, causing some lenders to experience 40-70% effective tax rate. It was a bit confusing for me.

Joleran

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Re: A concise way to explain the tax treatment of LC?
« Reply #3 on: October 21, 2013, 08:46:58 AM »
A comment thread on Peter's blog w/ "SoCalLender" mentioned something about how defaults were treated as capital losses, causing some lenders to experience 40-70% effective tax rate. It was a bit confusing for me.

This is true.  If you have any capital gains, you'll be losing out on the spread between your ordinary income tax rate and your capital gains tax rate for any losses.  Even if you don't have any gains, if you have more than $3k in capital losses, you can't offset all of the losses.

If, however, you don't have any appreciable capital gains and your default losses are less than $3000, or if you're in a 15% or lower tax bracket, Lending Club is not particularly tax disadvantaged.  And of course, if you have a traditional or Roth IRA there are no disadvantages.

Xin

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Re: A concise way to explain the tax treatment of LC?
« Reply #4 on: October 21, 2013, 10:53:46 PM »
if you're in a 15% or lower tax bracket, Lending Club is not particularly tax disadvantaged.

Why would this be?

bobeubanks

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Re: A concise way to explain the tax treatment of LC?
« Reply #5 on: October 21, 2013, 10:59:30 PM »
A comment thread on Peter's blog w/ "SoCalLender" mentioned something about how defaults were treated as capital losses, causing some lenders to experience 40-70% effective tax rate. It was a bit confusing for me.

I can't find that thread to get details, but I can't figure out how you can get an effective tax rat of 70%. A loss is a loss not a tax. You get some tax write-off for a loss, but that doesn't mean the remaining loss suddenly turns into tax. Unless you think if you lose a dollar on the street, that is a 100% effective tax rate.

core

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Re: A concise way to explain the tax treatment of LC?
« Reply #6 on: October 22, 2013, 12:08:58 AM »
I can't find that thread to get details, but I can't figure out how you can get an effective tax rat of 70%.

Say you were in the 35% bracket.  If you earned $1000 in interest, and had $1000 in defaults on notes held more than 1 year, you would owe $200 in taxes when you just broke even for the year.  That's a helluva lot worse than 70%, even worse than 100% -- it's an effective rate of infinity.  Just what Obama wants.

Also I haven't seen the loan servicing fees mentioned in this thread yet.  Isn't the amount listed on your 1099-OID the amount _before_ fees were taken out?  And you cannot deduct them in practice because of the 2% haircut.  I could be mistaken there -- April seems like a long time ago and the memory of doing my taxes is all too traumatic to recall.

bobeubanks

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Re: A concise way to explain the tax treatment of LC?
« Reply #7 on: October 22, 2013, 12:37:25 AM »
I can't find that thread to get details, but I can't figure out how you can get an effective tax rat of 70%.

Say you were in the 35% bracket.  If you earned $1000 in interest, and had $1000 in defaults on notes held more than 1 year, you would owe $200 in taxes when you just broke even for the year.  That's a helluva lot worse than 70%, even worse than 100% -- it's an effective rate of infinity.

$200 tax on $1000 earnings is 20%. The fact that $1000 defaulted is irrelevant other than the 15% deduction. None of that $1000 went to Uncle Sam.

core

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Re: A concise way to explain the tax treatment of LC?
« Reply #8 on: October 22, 2013, 01:04:07 AM »
$200 tax on $1000 earnings is 20%. The fact that $1000 defaulted is irrelevant other than the 15% deduction. None of that $1000 went to Uncle Sam.

Your net earnings were $0 and you paid $200 tax on it.  I don't believe the $1000 in defaults is any more irrelevant than any other business expense you might have.  Or if you made $1k on one stock trade and lost $1k on another trade. 

bobeubanks

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Re: A concise way to explain the tax treatment of LC?
« Reply #9 on: October 22, 2013, 01:25:44 AM »
$200 tax on $1000 earnings is 20%. The fact that $1000 defaulted is irrelevant other than the 15% deduction. None of that $1000 went to Uncle Sam.

Your net earnings were $0 and you paid $200 tax on it.  I don't believe the $1000 in defaults is any more irrelevant than any other business expense you might have.  Or if you made $1k on one stock trade and lost $1k on another trade.

I suppose you can look at it that way, but then someone might look at commuting as a working expense and then claim that their effective tax rate on their job is really higher than 35% (or whatever their bracket is).

In your example, your net earnings were $1000 and you only paid at a 20% tax rate because the gov't allows you to deduct a loss which is perhaps unrelated to the earnings.

I.E., instead of looking at it like Uncle Sam is screwing me with an infinite tax rate because I made a bad lending decision, look at it like at least Uncle Sam allows me to write off bad decisions when the average joe doesn't even get to write off the cost of getting to his job.

Joleran

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Re: A concise way to explain the tax treatment of LC?
« Reply #10 on: October 22, 2013, 12:50:33 PM »
if you're in a 15% or lower tax bracket, Lending Club is not particularly tax disadvantaged.

Why would this be?

Because capital gains are taxed at 15% (long term) or as regular income (short term), being in a 15% or lower tax bracket means you can offset your losses with capital gains and not have to worry that your gains from LC are being taxed as ordinary income.

Xin

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Re: A concise way to explain the tax treatment of LC?
« Reply #11 on: October 23, 2013, 04:35:00 AM »
if you're in a 15% or lower tax bracket, Lending Club is not particularly tax disadvantaged.

Why would this be?

Because capital gains are taxed at 15% (long term) or as regular income (short term), being in a 15% or lower tax bracket means you can offset your losses with capital gains and not have to worry that your gains from LC are being taxed as ordinary income.

I believe  LTCG rate for 15% bracket is  0%. http://sett.com/longtermreturns/taxes

Joleran

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Re: A concise way to explain the tax treatment of LC?
« Reply #12 on: October 23, 2013, 09:33:12 AM »
I believe  LTCG rate for 15% bracket is  0%. http://sett.com/longtermreturns/taxes

I thought that had been canceled as of this year but it appears you are correct.


Xin

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Re: A concise way to explain the tax treatment of LC?
« Reply #13 on: October 24, 2013, 07:54:22 PM »
I guess this is a little off topic, but it seems like tax brackets have become more progressive in the last decade. But my liberal friends keep saying it's become less progressive.

yojoakak

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Re: A concise way to explain the tax treatment of LC?
« Reply #14 on: October 24, 2013, 08:08:27 PM »
I guess this is a little off topic, but it seems like tax brackets have become more progressive in the last decade. But my liberal friends keep saying it's become less progressive.

I know right!

Unearned Income has never been been taxed at a lower rate! (That includes Welfare Benefits, right?)