TAXATION OF CAPITAL GAINS WITH DEFERRED REALIZATION

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Abstract
This paper examines accepted methods of calculating the effect of deferred realization on the effective rate of capital gains tax paid by common shareholders. These methods are shown to be tailored to the special case of gains accrued in lump sum, unlike the usual scenario of gains accrued gradually over time. A widely-accepted method is also shown to overstate the effect of deferral by implicitly relying on the internal rate of return concept. The valuation-based method proposed here is designed for growth stocks, where gains are accrued gradually and realized in lump sum. The same method is used to calculate the firm's cost of retained earnings under a finite deferral period.

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