Should after-tax returns always be calculated using the highest rate applicable to any federal income tax bracket?
A. Generally, yes. Instruction 4 to Item 21(b)(2) of Form N-1A and Instruction 4 to Item 21(b)(3) of Form N-1A provide that taxes due on distributions are to be calculated using the “highest individual marginal federal income tax rates.” Instruction 7(d) to Item 21(b)(3) of Form N-1A provides that capital gains taxes upon redemption are to be calculated using the “highest federal individual capital gains tax rate for gains of the appropriate character.” However, Instruction 4 to Item 21(b)(2) of Form N-1A and Instruction 4 to Item 21(b)(3) of Form N-1A also provide that the effect of phaseouts of certain exemptions, deductions, and credits at various income levels should be disregarded. As a result, there may be circumstances where the highest rate applicable to any federal income tax bracket is not used because that rate reflects the phaseout of certain exemptions, deductions, and/or credits. For example, the Tax Reform Act of 1986 created two tax brackets, 15% and 28%, with a 5% surc
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