If you have been online lately, you’ve noticed that many people have been investing in different ways, and asking all about investing and taxes. How do they go hand in hand? Is it too risky to invest if I am concerned about my taxes? As an accounting firm, we’ve been getting this main question: How does investing affect your taxes?
Like any other major events or steps, it is always important to look at every decision’s tax implications. So we commend you for looking further into how taxes and investing go hand in hand. To learn more keep reading some of the main tips we have for you today:
Let’s clear things up:
- If you receive income from investments, your taxes will be affected.
- If you sell an investment for a gain or loss, your taxes will be affected.Now that we cleared that up let’s continue!
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Income from investments
What should you know next about investing and taxes? So to start, in case you may not know, investment income normally includes interest and dividends. When you’re investing in something, it may seem like you just need to focus on the money given and the money gained after the fact, but it’s not that simple.
However, it is good to know that the income you receive from interest and unqualified dividends will be taxed at your ordinary-income tax rate. (What does that mean? Well, you’d have to look at your tax bracket to find out!) Some dividends can receive a special tax treatment, but all this information is specific to you!
This brings us to this point: You will need to talk to your tax specialist or an investment broker. In order to truly get the best understanding of investing and taxes, you need to talk to a tax specialist that can be there for you to answer all of your questions.
Let’s talk about Gains and Losses
When we talk about investing and taxes, we typically think of only dealing with the taxes when we have gains. To figure this out, you have to subtract your investment’s cost basis, which is normally what you paid, from the sale price to see if you had a gain.
If you have a gain on the sale, you’ll have to see if you owe taxes.
If there’s a loss, you may be able to offset other gains or take a deduction, depending on your situation. To qualify, you need to be selling a capital asset. Basically, a capital asset is household furnishings, stock or bonds, or even your home.
Two Types of Capital Gains
The next tip we have for investing and taxes are, there are two general types of capital gains, one being a short-term gain. Short-term capital gains are for capital assets you held for a year or less, and these gains are generally taxed at your ordinary-income tax rate. Therefore, anything you held on for more than a year would be considered a long-term capital gain. The long-term capital gains tax rates are typically lower than your ordinary income tax and generally max out at 20%.
It is good to note that some types of investments have higher capital gains tax rates. The most notable exception is collectibles, such as coins, rare stamps, art, and more. These types of investments have a capital gains tax rate that could be as high as 28%. In addition to the income taxes described above, those with significant income may be subject to the net investment income tax, which is an additional 3.8% tax on top of the usual capital gains taxes.
How to Offset these Gains
So obviously, the next concern everyone has is, what can you do to offset these gains? Well, you can offset your capital gains with your capital losses if you have any. There are both long-term and short-term capital losses, as mentioned above. If this isn’t making any sense to you, here is how it works:
- First, you must net your capital gains and capital losses of the same kind. That means subtracting short-term capital losses from short-term capital gains and long-term capital losses from long-term capital gains.
- If you end up having a short-term or long-term capital loss remaining, you can then reduce your short-term losses with your long-term gains or vice versa.
- If you still have more capital losses than capital gains in a year, most filing statuses can use up to $3,000 of any capital losses remaining to offset your ordinary income.
- Any excess capital losses above that amount can be carried over to future tax years to offset future income according to the rules above.
Tax Tips to Keep in Mind
One of the trickiest things to keep in mind is that certain types of investments can have special tax treatment. For example, municipal bonds are normally tax-free for federal income taxes. However, they may be taxable on your state tax return, depending on the state you live in and the state that issued the bond you invested in.
- A bigger exception is money in tax-advantaged retirement accounts. For example, a traditional retirement account such as an IRA or 401k may allow you to take a tax deduction today. After, the investments within the account grow tax-free, but when you take out the money, it’ll be considered ordinary income. So you will likely have to pay taxes on this income.
- The other main type of tax-advantaged retirement accounts that are treated differently is Roth retirement accounts, such as a Roth IRA or Roth 401(k). You don’t get a tax deduction for contributing to these accounts. However, the money can grow tax-free and you can withdraw it tax-free, including the investment gains when you are eligible to do so.
We hope that you keep looking into how investing affects your taxes. We know that investing and taxes are both huge topics that require lots of research and expertise, which is why we recommend working with a tax specialist that can guide you. If you are looking to know more, or work with a professional tax firm, feel free to contact our team for a free consultation.