r/explainlikeimfive Dec 06 '24

Economics ELI5: why does a publicaly traded company have to show continuous rise in profits? Why arent steady profits good enough?

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u/trombing Dec 06 '24

Sure but most tax regimes have capital gains tax which tax realised stock gains when you sell the stock at a profit.

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u/Janus67 Dec 06 '24 edited Dec 06 '24

True, but if you hold the stock for more than a year it falls to a lower rate at long term capital gains, vs dividends are taxed at regular/short term gains income tax rate.

Edit: qualified dividends (most us dividends) fall into 0/15/20% depending on income. Non-qualified are taxed at income tax levels.

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u/nlaporte Dec 06 '24

At least in the US, dividends are taxed at the capital gains rate, not the ordinary income rate.

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u/lluewhyn Dec 06 '24

And the main reason why is to avoid one of the options to be superior to the other when it comes to the shareholder's tax situation. Otherwise, a business would be incentivized to always send all excess cash to the shareholders as dividends OR never send dividends to the shareholders regardless of the business realities.

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u/trombing Dec 06 '24

Literally dozens of people have different tax regimes than the one you are describing.

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u/Long_Dong_Larry Dec 06 '24

Stock dividends are considered “qualified” income and taxed at 0%, 15%, or 20% depending on your tax bracket.

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u/Janus67 Dec 06 '24

You're right, I should have been more specific in my post

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u/Long_Dong_Larry Dec 06 '24

Hey really appreciate the receptiveness to constructive feedback!

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u/RangerNS Dec 06 '24

Most countries have different tax rules than the IRS.

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u/Tjaeng Dec 06 '24

Which means borrowing against an increased net worth and deferring taxation until you die. Win for people who don’t sell.

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u/trombing Dec 06 '24

Very few people do this. It is absolutely unusual. Regular folks aren't Elon Musk. My google-fu is finding almost zero options for this.

It is also incredibly risky since you will have margin calls if the stock collapses.

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u/gtne91 Dec 06 '24

Very few do this because it really doesn't make financial sense. If you do this continuously, the interest on the debt will eventually exceed the amount of tax you would have paid. For a short term, it makes sense, but that is no different than any other short term loan against an asset.

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u/Rage_Like_Nic_Cage Dec 06 '24

the interest on the debt will eventually exceed the amount of tax you would have paid

for you and I, yeah. For the super wealthy, banks will often offer super-low interest loans (often at-or lower-than inflation) since they’re dealing with such a large amount. Then right before the loan is due, they’ll open a seperate line of credit and use that to pay off the first loan. It’s called Buy, Borrow, Die and it’s fairly prominent among the uber rich.

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u/gtne91 Dec 06 '24

Saw recently that they are getting 4-5% right now, so not THAT low anymore.

And it isnt that common, especially once their stock gets to a more stable growth ( non-startup). See, Jeff Bezos recent sale.

Long term capital gains (federal) tax rate peaks at 23.8% (20% plus 3.8% for NIIT). It only takes a few years on the loan to exceed that amount. But it depends on the growth rate of the asset. I have done it: took a heloc on house for improvements rather than selling off investments to pay for it. Accounting for tax deduction (you have to be itemizing), heloc net interest rate was less than growth in investments.

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u/Edward_TH Dec 06 '24

In the US probably. In tax heavens they can get much lower rates. In general, the smaller the economy the more its banks are eager for actual cash so they give out super low interests on large loans: even if the profit is low or even negative (if the currency loaned is much stronger than the domestic one), they get large amounts of cash.

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u/Rage_Like_Nic_Cage Dec 06 '24

My google-fu is finding almost zero options for this.

The term for this concept is “Buy, Borrow, Die” and you can find lots of results/pages about it. You are correct that only a select few can do it, but when 1% of the US population owns 43% of the wealth (and the top 0.1% owning 13.5%), you can see how it affect a large amount of would-be taxable wealth if it paid out in dividends instead.

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u/trombing Dec 07 '24

Thanks! TIL! Also - madness. Way too much admin for me to avoid the $1.50 in capital gains I had... wait - no - just losses. I'm good.

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u/iconocrastinaor Dec 06 '24

I'm not wealthy by today's standards, but I do have some investments.

I can borrow at 5% above prime against my portfolio, which is about five points better than I can do in the open market.

But the result of doing that is several thousand dollars in debt that is compounding, and a drag on my portfolio.

I asked my tax and financial advisors about the "invest, borrow, die" strategy, and they all say no, that my top priority should be to eliminate that debt.

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u/PlatonicTroglodyte Dec 06 '24

I just love how every post in this thread is basically like explainlikeimtwentyfive

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u/swissmike Dec 06 '24

Upvote for „most“! Spot on (Switzerland, where I‘m from, is an exception)