Total International still more tax efficient than Total US?
Total International still more tax efficient than Total US?
Now that the 2013 1099-DIV's have been issued, can someone shed some light on which fund is more tax efficient and more ideal to be held in taxable?
I know the dividend yield, % of dividend that is qualified, and % of foreign tax credit determine this, but not sure how to quantify.
I know the dividend yield, % of dividend that is qualified, and % of foreign tax credit determine this, but not sure how to quantify.
Re: Total International still more tax efficient than Total
It depends on your tax bracket; most after-tax returns assume the top tax bracket but ignore the 3.8% Medicare surtax.
In a 28% tax bracket, the dividends on Total Stock Market are taxed at 15% (all or almost all qualified), and the dividends on an international fund are taxed about 70% at 15%, 30% at 28%, but with a 7% foreign tax credit for a net tax rate of 12%. Thus, if the yield on Total Stock Market is 80% of the yield on an international fund, the two funds are equally tax-efficient. If you also pay state tax, the break-even point becomes higher than 80%, as most states tax both funds at the same rate.
Last year, Total Stock Market Admiral had a 1.74% yield, and Total International Admiral had a 2.71% yield (data from M*), so Total Stock Market was more tax-efficient.
In a 28% tax bracket, the dividends on Total Stock Market are taxed at 15% (all or almost all qualified), and the dividends on an international fund are taxed about 70% at 15%, 30% at 28%, but with a 7% foreign tax credit for a net tax rate of 12%. Thus, if the yield on Total Stock Market is 80% of the yield on an international fund, the two funds are equally tax-efficient. If you also pay state tax, the break-even point becomes higher than 80%, as most states tax both funds at the same rate.
Last year, Total Stock Market Admiral had a 1.74% yield, and Total International Admiral had a 2.71% yield (data from M*), so Total Stock Market was more tax-efficient.
Re: Total International still more tax efficient than Total
Give me the numbers including foreign taxes paid and I will put it in my spreadsheet and let you know. It's gonna be very close.
Last edited by livesoft on Sun Jan 19, 2014 7:05 pm, edited 1 time in total.
Re: Total International still more tax efficient than Total
David,
Have you done the calculation with the 2013 dividend information? I am curious about the 15% bracket, no state income taxes.
Have you done the calculation with the 2013 dividend information? I am curious about the 15% bracket, no state income taxes.
Re: Total International still more tax efficient than Total
In the 15% tax bracket, the tax cost of Total Stock Market is zero. 30% of the Total International dividend is taxed at 15% (it was 33% this year), and with the 7% foreign tax credit, your net tax cost on Total International is -2% of the dividend. (There is an IRS rule which would prevent you from taking the full credit in some situations, but if you are in the 15% bracket, it is unlikely that you have the $20,000 in foreign income which would cause it to matter.)SobeCane wrote:David,
Have you done the calculation with the 2013 dividend information? I am curious about the 15% bracket, no state income taxes.
Re: Total International still more tax efficient than Total
Is the tax cost of Total US really 0? I remember reading a post recently where someone mentioned that they were shocked Total US was only 94% qualifies for 2013.
Re: Total International still more tax efficient than Total
In the 15% tax bracket, with no state taxes, the tax cost is zero with 100% qualified dividends. With 94% qualified dividends from this year and a 1.74% yield, the non-qualified dividend yield is 0.10%, so the tax cost is 0.015%, which is trivial but not quite zero; it's $3 if you have $20,000 invested.SobeCane wrote:Is the tax cost of Total US really 0? I remember reading a post recently where someone mentioned that they were shocked Total US was only 94% qualifies for 2013.
Re: Total International still more tax efficient than Total
It is nearly a wash in the 25% bracket.
With only 94% of VTSAX dividends being QDI, the tax cost is about 28 bps at a 1.8% dividend yield.
On my VFWAX (FTSE AW ex-US) I calculate a tax cost of 36 bps net of the FTC.
Not enough difference to get excited about.
Certainly not enough to sell VFWAX in taxable and book a 6 figure cap gain.
With only 94% of VTSAX dividends being QDI, the tax cost is about 28 bps at a 1.8% dividend yield.
On my VFWAX (FTSE AW ex-US) I calculate a tax cost of 36 bps net of the FTC.
Not enough difference to get excited about.
Certainly not enough to sell VFWAX in taxable and book a 6 figure cap gain.
Re: Total International still more tax efficient than Total
Does this mean that if you are in the 15% bracket, you actually get a tax benefit from owning TISM in a taxable account? It doesn't apply to me directly but indirectly it is quite interesting...grabiner wrote:In the 15% tax bracket, the tax cost of Total Stock Market is zero. 30% of the Total International dividend is taxed at 15% (it was 33% this year), and with the 7% foreign tax credit, your net tax cost on Total International is -2% of the dividend. (There is an IRS rule which would prevent you from taking the full credit in some situations, but if you are in the 15% bracket, it is unlikely that you have the $20,000 in foreign income which would cause it to matter.)SobeCane wrote:David,
Have you done the calculation with the 2013 dividend information? I am curious about the 15% bracket, no state income taxes.
Re: Total International still more tax efficient than Total
Yes, this is correct. In theory, you should only get a foreign tax credit up to the prorated share of US tax you paid on the foreign income, but the IRS doesn't require you to adjust the proration for the lower tax on qualified dividends unless you have very high total or foreign income.Calm Man wrote:Does this mean that if you are in the 15% bracket, you actually get a tax benefit from owning TISM in a taxable account? It doesn't apply to me directly but indirectly it is quite interesting...grabiner wrote:In the 15% tax bracket, the tax cost of Total Stock Market is zero. 30% of the Total International dividend is taxed at 15% (it was 33% this year), and with the 7% foreign tax credit, your net tax cost on Total International is -2% of the dividend. (There is an IRS rule which would prevent you from taking the full credit in some situations, but if you are in the 15% bracket, it is unlikely that you have the $20,000 in foreign income which would cause it to matter.)
Re: Total International still more tax efficient than Total
Would this be considered tax porn
"Out of clutter, find simplicity” Albert Einstein
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Re: Total International still more tax efficient than Total
I don't get to caught up in this. We have both Total Stock and Total International in our taxable accounts.
We are thankful for the simplicity and the results. An investor has to find what works for them. Everyone may have a different strategy.
Best.
We are thankful for the simplicity and the results. An investor has to find what works for them. Everyone may have a different strategy.
Best.
John C. Bogle: “Simplicity is the master key to financial success."
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Re: Total International still more tax efficient than Total
For your amusement, here are my calculations of the 2013 tax-efficiency of three Vanguard Admiral funds: VTSAX, VSMAX (Small Cap Index), and VTIAX (Total International). I would throw VFWAX (FTSE Large) into the mix, but VG has not yet posted the official rates of foreign taxes withheld from their international funds.
As it is, I only have an estimate of the rate for Total International, based on my 1099-DIV. It came in at about 5.775%, a tad higher than last year.
The tax costs below are based on an initial investment of $100,000.
So a tax of $10 represents 1 basis point.
First, the case of an investor in the 25% Federal bracket, and paying state income tax at the rate of 5%.
So you see that VSMAX was the most tax-efficient of the three, and that VTIAX cost about 5.5bp extra in Fed taxes, and 4.6bp extra in State taxes, compared to TSM.
Note that this calculation assumes that you held $100,000 in the fund on 1/1/2013, and that there were no additional investments. Of course any additions, such as dividend reinvestments, would generate additional tax costs.
Now the case of an investor in a 15%+5% Federal+State bracket:
Here TSM is the most tax-efficient, and small caps are in last place.
But the really amusing situation is the case of an investor in the 15% Federal bracket, living in a state with no income tax. This investor has really played her cards well: Total International wins, with a negative tax cost! So the hypothetical situation discussed upthread was a reality in 2013.
As it is, I only have an estimate of the rate for Total International, based on my 1099-DIV. It came in at about 5.775%, a tad higher than last year.
The tax costs below are based on an initial investment of $100,000.
So a tax of $10 represents 1 basis point.
First, the case of an investor in the 25% Federal bracket, and paying state income tax at the rate of 5%.
Code: Select all
VTSAX VSMAX VTIAX
NAV on Jan 1 $35.65 $38.76 $25.05
Num. shares 2805.049 2579.979 3992.016
Divs/share $0.814 $0.689 $0.758
Divs paid out $2283.31 $1777.61 $3025.95
FTC rate 0.0000% 0.0000% 5.7750%
FTC $0.00 $0.00 $174.75
Taxable divs $2283.31 $1777.61 $3200.70
Qualified divs 94.35% 63.36% 66.97%
Fed tax $355.40 $331.77 $411.07
State tax $114.17 $88.88 $160.04
Total tax $469.57 $420.65 $571.11
Note that this calculation assumes that you held $100,000 in the fund on 1/1/2013, and that there were no additional investments. Of course any additions, such as dividend reinvestments, would generate additional tax costs.
Now the case of an investor in a 15%+5% Federal+State bracket:
Code: Select all
VTSAX VSMAX VTIAX
NAV on Jan 1 $35.65 $38.76 $25.05
Num. shares 2805.049 2579.979 3992.016
Divs/share $0.814 $0.689 $0.758
Divs paid out $2283.31 $1777.61 $3025.95
FTC rate 0.0000% 0.0000% 5.7750%
FTC $0.00 $0.00 $174.75
Taxable divs $2283.31 $1777.61 $3200.70
Qualified divs 94.35% 63.36% 66.97%
Fed tax $19.35 $97.70 $-16.17
State tax $114.17 $88.88 $160.04
Total tax $133.52 $186.58 $143.87
But the really amusing situation is the case of an investor in the 15% Federal bracket, living in a state with no income tax. This investor has really played her cards well: Total International wins, with a negative tax cost! So the hypothetical situation discussed upthread was a reality in 2013.
Re: Total International still more tax efficient than Total
I have my 1099 Div from VFWAX.House Blend wrote: I would throw VFWAX (FTSE Large) into the mix, but VG has not yet posted the official rates of foreign taxes withheld from their international funds.
1a $16,217.38
1b $11,347.30 (70%)
6 $894.84 (5.5%)
So I guess for a person in the 15% bracket with no state tax, VFWAX would cost 15%*(16217.38-11347.30)-894.84 = -$164.33 in tax
Even here in PA with a flat 3.07% tax, the person in the 15% bracket would pay negative tax of almost $15. Less if they itemize and deduct the state tax paid.
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Re: Total International still more tax efficient than Total
Total Int'l gave me slightly more ordinary dividends and slightly less qualified dividends than TSM despite roughly equal allocations to both funds. Neither gave me a capital gain distribution. I got a whopping $40 in Box 6 for Foreign Taxes paid which, for me, turns into a staggering $10 foreign tax credit. I'd call it a wash honestly but that's just me and my circumstances, YMMV.
Re: Total International still more tax efficient than Total
For international funds, tax efficiency is slightly different than the question of whether to hold a fund in a taxable or tax-advantaged account. You always pay the foreign tax withholding up front, so the absolute tax cost of an international fund can never be negative, it's just that the relative tax cost relative to what you would have paid if you held it in a tax-advantaged account (i.e. the foreign tax withholding) might be negative.
So TISM is less tax efficient than TSM in an absolute sense: there is a higher dividend yield, a lower percentage of the dividends are qualified, and the best you can do with the foreign tax credit is to get back the entire withholding.
So TISM is less tax efficient than TSM in an absolute sense: there is a higher dividend yield, a lower percentage of the dividends are qualified, and the best you can do with the foreign tax credit is to get back the entire withholding.
Most of my posts assume no behavioral errors.
Re: Total International still more tax efficient than Total
Do these findings imply reconsideration of the advice typically offered here (to place international equities in taxable account) or is these results more likely an exception to the rule of international equity funds being more tax efficient than domestic equity funds on account of the foreign tax credit? I confess I've never been a big fan of citing the FTC as a reason to place international equities in taxable accounts; it's true if all other factors are equal but that analysis seems a bit simplistic. Perhaps that is the best rule we can come up with, however, since future yields (and qualified percentages) are difficult to predict. On that basis, my international equity funds are entirely in my taxable account so I do not vehemently disagree with the rule of thumb.
Re: Total International still more tax efficient than Total
Very intelligent. I think none of us really considered that the foreign tax credit is on money not paid to us but on which we are taxed. In fact, for the state taxes (I am in NJ which doesn't have a foreign tax credit) it means we are even paying tax on the total dividends that include the withheld foreign taxes, right? Grrr.baw703916 wrote:For international funds, tax efficiency is slightly different than the question of whether to hold a fund in a taxable or tax-advantaged account. You always pay the foreign tax withholding up front, so the absolute tax cost of an international fund can never be negative, it's just that the relative tax cost relative to what you would have paid if you held it in a tax-advantaged account (i.e. the foreign tax withholding) might be negative.
So TISM is less tax efficient than TSM in an absolute sense: there is a higher dividend yield, a lower percentage of the dividends are qualified, and the best you can do with the foreign tax credit is to get back the entire withholding.
Re: Total International still more tax efficient than Total
Thanks for the compliment, calm man
I've heard that NJ also has some strange quirks involving non-401k retirement accounts. You have my sympathy.
I've heard that NJ also has some strange quirks involving non-401k retirement accounts. You have my sympathy.
Most of my posts assume no behavioral errors.
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Re: Total International still more tax efficient than Total
Uhh, speak for yourself. If you read your 1099-DIV, and compare it with the dividends reported on your annual statement, you'll see that you're paying Federal income tax on money that you never received.Calm Man wrote:I think none of us really considered that the foreign tax credit is on money not paid to us but on which we are taxed.
That's why there is a foreign tax credit in the first place.
(But good luck convincing your state to follow suit.)
Re: Total International still more tax efficient than Total
Indeed. Fortunately I have not been affected by the insanity here with non-401K accounts. The state is crazy in that you cannot deduct stock losses - we have a gross income tax with no deductions of any kind except a real estate tax credit or deduction, a personal exemption of something like $1500 and dependent exemptions of I think $1000. Throw in a college child exemption of something like $1000. If you are low income various goodies appear but that would be unlikely to affect anybody here. I see little hope for improvement in the tax situation here as we are dominated by groups that require taxpayer money -- however, I am here for good so I put up with it...baw703916 wrote:Thanks for the compliment, calm man
I've heard that NJ also has some strange quirks involving non-401k retirement accounts. You have my sympathy.
Re: Total International still more tax efficient than Total
I see what you are saying and even looked at the numbers. But I never thought about it in this fashion which I consider intelligent. Of course intelligent to one person might be obvious to another and that is good for the person to whom it was obvious and a little sad for the person (me) to whom it wasn'tHouse Blend wrote:Uhh, speak for yourself. If you read your 1099-DIV, and compare it with the dividends reported on your annual statement, you'll see that you're paying Federal income tax on money that you never received.Calm Man wrote:I think none of us really considered that the foreign tax credit is on money not paid to us but on which we are taxed.
That's why there is a foreign tax credit in the first place.
(But good luck convincing your state to follow suit.)
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Re: Total International still more tax efficient than Total
The way Vanguard reports foreign tax rates, the rate would bedickenjb wrote:I have my 1099 Div from VFWAX.House Blend wrote: I would throw VFWAX (FTSE Large) into the mix, but VG has not yet posted the official rates of foreign taxes withheld from their international funds.
1a $16,217.38
1b $11,347.30 (70%)
6 $894.84 (5.5%)
So I guess for a person in the 15% bracket with no state tax, VFWAX would cost 15%*(16217.38-11347.30)-894.84 = -$164.33 in tax
894.84/(16217.38-894.84) = about 5.840%.
Here's an updated pair of tables including VFWAX.
First, the 25%+5% taxpaying standard deducter:
Code: Select all
VTSAX VSMAX VTIAX VFWAX
NAV on Jan 1 $35.65 $38.76 $25.05 $28.21
Num. shares 2805.049 2579.979 3992.016 3544.842
Divs/share $0.814 $0.689 $0.758 $0.840
Divs paid out $2283.31 $1777.61 $3025.95 $2977.67
FTC rate 0.0000% 0.0000% 5.7750% 5.8400%
FTC $0.00 $0.00 $174.75 $173.90
Taxable divs $2283.31 $1777.61 $3200.70 $3151.57
Qualified divs 94.35% 63.36% 66.97% 69.97%
Fed tax $355.40 $331.77 $411.07 $393.48
State tax $114.17 $88.88 $160.04 $157.58
Total tax $469.57 $420.65 $571.11 $551.06
Code: Select all
VTSAX VSMAX VTIAX VFWAX
NAV on Jan 1 $35.65 $38.76 $25.05 $28.21
Num. shares 2805.049 2579.979 3992.016 3544.842
Divs/share $0.814 $0.689 $0.758 $0.840
Divs paid out $2283.31 $1777.61 $3025.95 $2977.67
FTC rate 0.0000% 0.0000% 5.7750% 5.8400%
FTC $0.00 $0.00 $174.75 $173.90
Taxable divs $2283.31 $1777.61 $3200.70 $3151.57
Qualified divs 94.35% 63.36% 66.97% 69.97%
Fed tax $19.35 $97.70 $-16.17 $-31.94
State tax $114.17 $88.88 $160.04 $157.58
Total tax $133.52 $186.58 $143.87 $125.64
Re: Total International still more tax efficient than Total
I swear every time I learn something more about NJ taxes it's something where they're different from everyone else in a bad way.Calm Man wrote:Very intelligent. I think none of us really considered that the foreign tax credit is on money not paid to us but on which we are taxed. In fact, for the state taxes (I am in NJ which doesn't have a foreign tax credit) it means we are even paying tax on the total dividends that include the withheld foreign taxes, right? Grrr.baw703916 wrote:For international funds, tax efficiency is slightly different than the question of whether to hold a fund in a taxable or tax-advantaged account. You always pay the foreign tax withholding up front, so the absolute tax cost of an international fund can never be negative, it's just that the relative tax cost relative to what you would have paid if you held it in a tax-advantaged account (i.e. the foreign tax withholding) might be negative.
So TISM is less tax efficient than TSM in an absolute sense: there is a higher dividend yield, a lower percentage of the dividends are qualified, and the best you can do with the foreign tax credit is to get back the entire withholding.
What would be the threshold for low income?Calm Man wrote:Indeed. Fortunately I have not been affected by the insanity here with non-401K accounts. The state is crazy in that you cannot deduct stock losses - we have a gross income tax with no deductions of any kind except a real estate tax credit or deduction, a personal exemption of something like $1500 and dependent exemptions of I think $1000. Throw in a college child exemption of something like $1000. If you are low income various goodies appear but that would be unlikely to affect anybody here. I see little hope for improvement in the tax situation here as we are dominated by groups that require taxpayer money -- however, I am here for good so I put up with it...baw703916 wrote:Thanks for the compliment, calm man
I've heard that NJ also has some strange quirks involving non-401k retirement accounts. You have my sympathy.
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Re: Total International still more tax efficient than Total
A minor consideration which probably hits few investors is the foreign tax paid credit is nonrefundable. If your federal income tax liability is zero you end up paying income tax to other countries that isn't made up for here. I believe livesoft has posted extensively about how to structure retirement income with no federal taxes due.
With respect to tax on income never received, how is it any different from having income taxes withheld from one's paycheck? The gross dividends are $X, the net you're paid is <$X, and the difference is the tax. What's not to understand about that? Then assuming you can take the whole credit you get it all back. Where's the problem?
PJW
With respect to tax on income never received, how is it any different from having income taxes withheld from one's paycheck? The gross dividends are $X, the net you're paid is <$X, and the difference is the tax. What's not to understand about that? Then assuming you can take the whole credit you get it all back. Where's the problem?
PJW
Re: Total International still more tax efficient than Total
It's something like not paying taxes on pensions below $20,000 of income and there is some sort of credit below that. It's not very high because most people are middle class and they are where the money is. I know 2 corporate execs, the total comp type of guys at 5 million, , who get driven to work by a company provided driver. [OT comments removed by admin LadyGeek]ajcp wrote:I swear every time I learn something more about NJ taxes it's something where they're different from everyone else in a bad way.Calm Man wrote:Very intelligent. I think none of us really considered that the foreign tax credit is on money not paid to us but on which we are taxed. In fact, for the state taxes (I am in NJ which doesn't have a foreign tax credit) it means we are even paying tax on the total dividends that include the withheld foreign taxes, right? Grrr.baw703916 wrote:For international funds, tax efficiency is slightly different than the question of whether to hold a fund in a taxable or tax-advantaged account. You always pay the foreign tax withholding up front, so the absolute tax cost of an international fund can never be negative, it's just that the relative tax cost relative to what you would have paid if you held it in a tax-advantaged account (i.e. the foreign tax withholding) might be negative.
So TISM is less tax efficient than TSM in an absolute sense: there is a higher dividend yield, a lower percentage of the dividends are qualified, and the best you can do with the foreign tax credit is to get back the entire withholding.
What would be the threshold for low income?Calm Man wrote:Indeed. Fortunately I have not been affected by the insanity here with non-401K accounts. The state is crazy in that you cannot deduct stock losses - we have a gross income tax with no deductions of any kind except a real estate tax credit or deduction, a personal exemption of something like $1500 and dependent exemptions of I think $1000. Throw in a college child exemption of something like $1000. If you are low income various goodies appear but that would be unlikely to affect anybody here. I see little hope for improvement in the tax situation here as we are dominated by groups that require taxpayer money -- however, I am here for good so I put up with it...baw703916 wrote:Thanks for the compliment, calm man
I've heard that NJ also has some strange quirks involving non-401k retirement accounts. You have my sympathy.
Re: Total International still more tax efficient than Total
Because going to the extreme, if your tax rate is zero, your gross income equals your net income for earnings. If your tax rate is zero, your net is less than your gross because foreign taxes are withheld. Then just extrapolate up and I think you'll get it if you think about it a bit. (It's not obvious or easy to figure out but you are smart I know from other posts so it will dawn on you suddenly. Took me awhile.)Phineas J. Whoopee wrote:A minor consideration which probably hits few investors is the foreign tax paid credit is nonrefundable. If your federal income tax liability is zero you end up paying income tax to other countries that isn't made up for here. I believe livesoft has posted extensively about how to structure retirement income with no federal taxes due.
With respect to tax on income never received, how is it any different from having income taxes withheld from one's paycheck? The gross dividends are $X, the net you're paid is <$X, and the difference is the tax. What's not to understand about that? Then assuming you can take the whole credit you get it all back. Where's the problem?
PJW
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Re: Total International still more tax efficient than Total
Thanks for the compliment.Calm Man wrote:Because going to the extreme, if your tax rate is zero, your gross income equals your net income for earnings. If your tax rate is zero, your net is less than your gross because foreign taxes are withheld. Then just extrapolate up and I think you'll get it if you think about it a bit. (It's not obvious or easy to figure out but you are smart I know from other posts so it will dawn on you suddenly. Took me awhile.)Phineas J. Whoopee wrote:A minor consideration which probably hits few investors is the foreign tax paid credit is nonrefundable. If your federal income tax liability is zero you end up paying income tax to other countries that isn't made up for here. I believe livesoft has posted extensively about how to structure retirement income with no federal taxes due.
With respect to tax on income never received, how is it any different from having income taxes withheld from one's paycheck? The gross dividends are $X, the net you're paid is <$X, and the difference is the tax. What's not to understand about that? Then assuming you can take the whole credit you get it all back. Where's the problem?
PJW
Yeah. That's what I just said, isn't it? If you have no U.S. federal income tax liability you get nothing back and paid income tax to other countries. I said that. If you have liability in excess of the foreign tax paid credit you get it all back. I said that. There are other nonrefundable credits. Reading from my 2012 1040 they seem to be: Credit for child and dependent care expenses; Education credits; Retirement savings contribution credit; Child tax credit; Residential energy credits; Credits from forms 3800 and 8801; and any other nonrefundable credits (you have to fill in what form they're from). Is that what you're talking about?
Is your point that if one has liability more than zero but less than the foreign tax paid one only gets part of it back? That's certainly true but it doesn't seem like what you meant, because you said "if your tax rate is zero."
The point of my post was to account for the zero-tax situation. Wasn't it?
I thought it was.
PJW
Re: Total International still more tax efficient than Total
There are other reasons to have Intl in taxable. Many 401k offer very low cost US index funds but offer only active and high cost Intl funds. This expense difference can easily be .5%. It swamps almost any comparison of tax efficiency since tax efficiency is usually a flip of the coin from year to year. Without knowing anything else, this alone would suggest the default should be Intl in taxable and it would be right more times than not.jjbiv wrote:Do these findings imply reconsideration of the advice typically offered here (to place international equities in taxable account) or is these results more likely an exception to the rule of international equity funds being more tax efficient than domestic equity funds on account of the foreign tax credit? I confess I've never been a big fan of citing the FTC as a reason to place international equities in taxable accounts; it's true if all other factors are equal but that analysis seems a bit simplistic. Perhaps that is the best rule we can come up with, however, since future yields (and qualified percentages) are difficult to predict. On that basis, my international equity funds are entirely in my taxable account so I do not vehemently disagree with the rule of thumb.
If one does have access to low cost Intl in 401k, it might still make sense to put some Intl in taxable for Tax Loss Harvesting reasons. Again, since it's often a flip of the coin which is more efficient, you might as well put both in taxable to increase your chances of TLH.
Re: Total International still more tax efficient than Total
And an important exception is the US Government's TSP, which offers US and international indexes at the same cost. The benefit of the foreign tax credit for Developed Markets Index in a taxable account is probably less than the cost of the partially non-qualified dividends and the higher expense ratio for Vanguard's international funds compared to Vanguard Total Stock Market. (If you do this, you would still need to hold Emerging Markets Index and FTSE All-World Ex-US Small-Cap in your taxable account or IRA in order to replicate Total International.)bdpb wrote:There are other reasons to have Intl in taxable. Many 401k offer very low cost US index funds but offer only active and high cost Intl funds. This expense difference can easily be .5%. It swamps almost any comparison of tax efficiency since tax efficiency is usually a flip of the coin from year to year. Without knowing anything else, this alone would suggest the default should be Intl in taxable and it would be right more times than not.
Re: Total International still more tax efficient than Total
This is fascinating and is what I believe is happening on my tax return. Does this benefit end when my foreign taxes paid exceed 300 or when my total dividend income from the international fund exceeds 20,000? Obviously, the former will occurs much sooner.grabiner wrote:Yes, this is correct. In theory, you should only get a foreign tax credit up to the prorated share of US tax you paid on the foreign income, but the IRS doesn't require you to adjust the proration for the lower tax on qualified dividends unless you have very high total or foreign income.Calm Man wrote:Does this mean that if you are in the 15% bracket, you actually get a tax benefit from owning TISM in a taxable account? It doesn't apply to me directly but indirectly it is quite interesting...grabiner wrote:In the 15% tax bracket, the tax cost of Total Stock Market is zero. 30% of the Total International dividend is taxed at 15% (it was 33% this year), and with the 7% foreign tax credit, your net tax cost on Total International is -2% of the dividend. (There is an IRS rule which would prevent you from taking the full credit in some situations, but if you are in the 15% bracket, it is unlikely that you have the $20,000 in foreign income which would cause it to matter.)
Re: Total International still more tax efficient than Total
There are three categories for the foreign tax credit.SobeCane wrote:This is fascinating and is what I believe is happening on my tax return. Does this benefit end when my foreign taxes paid exceed 300 or when my total dividend income from the international fund exceeds 20,000? Obviously, the former will occurs much sooner.grabiner wrote:Yes, this is correct. In theory, you should only get a foreign tax credit up to the prorated share of US tax you paid on the foreign income, but the IRS doesn't require you to adjust the proration for the lower tax on qualified dividends unless you have very high total or foreign income.
If your foreign tax is less than $300 single/$600 married and comes all from investments, you don't need to file Form 1116 at all, and can take the whole tax as a credit.
Otherwise, you must file Form 1116, and your credit is limited to the lower of the foreign tax you actually paid or a prorated share of your US tax, divided by category of income. For example, if you paid $5000 in US tax, and 10% of your income is foreign, you can take a foreign tax credit of no more than $500; if you paid $700 in foreign tax, the extra $200 can be carried over to another year in which your foreign tax is lower than the prorated US tax.
And if your foreign qualified dividends and capital gains are at least $20,000, or if you are in the 33% or higher tax bracket (this isn't what the instructions say, but it is how the income limits work), then you must make a second adjustment for the fact that your foreign qualified dividends and capital gains were taxed at a lower rate. Foreign income taxed at 0% does not count as income, foreign income taxed at 15% counts at a factor of 15/39.6, and foreign income taxed at 20% counts at a factor of 20/39.6. (Note that capital gains for a US investor on US-based foreign mutual funds or stocks traded on a US exchange are not foreign-source capital gains, because they are not taxed by the foreign country.)