While many people tend to focus on how much money their investments will produce for them, it can be equally as important to understand how the IRS will tax this income. In this post, we’ll explore the tax treatments on interest, capital gains, and dividends, and then discuss how you can use this knowledge to your advantage.
Most forms of interest are considered to be taxable in the same way as money you would have earned from your employer (also known as ordinary income). Examples would be interest earned on savings accounts, money market accounts, CDs, etc.
If you’ve got treasury bills, notes, or bonds, then you will also owe ordinary income taxes at the federal level, but they would be exempt from state and local taxes. Alternatively, the interest on municipal bonds is tax-exempt at the federal level, but you will be taxed at the state level.
If you’ve got any U.S. savings bonds (series EE or I), the interest you’d receive is also taxable at the federal level. However, you only need to declare it at the time of redemption.
Anytime you sell an asset such as a stock, bond, or piece of real estate for more than you bought it for, this is called a capital gain. According to the IRS, capital gains are classified and taxed in one of two ways:
Short-Term Capital Gains
Short-term capital gains are assets owned for one year or less. An example of this would be a stock you purchased and then sold six months later. These types of assets are treated just like ordinary income and receive no special tax benefits.
Long-Term Capital Gains
Long-term capital gains are assets owned for more than one year. An example of this would be a stock you purchased and then sold five years later. These types of assets classically receive better tax treatment than short-term capital gains or ordinary income.
Just like with gains, you can also declare capital losses if you sold any assets for less than what you paid for them. Losses can be combined with your gains to offset your “net capital gain” which is actually the amount you will be taxed on.
Non-qualified dividends are usually those payments that don’t meet the requirements to be considered qualified dividends. However, they can also include other types of dividends such as those from employee stock options and real estate investment trusts. Just as the name implies, non-qualified dividends will not receive special tax treatment and will be taxed as ordinary income.
Taxes on Long-Term Capital Gains and Qualified Dividends
Depending on your adjusted gross income and filing status, you will pay the following taxes based on the earnings you receive according to these brackets for 2021:
- 0% on $0 – $40,400 for individual filers and $0 – $80,800 and married filing joint
- 15% on $40,400 – $445,850 for individual filers and $80,800 – $501,600 and married filing joint
- 20% on $445,850 or more for individual filers and $501,600 or more and married filing joint
Using Capital Gains and Dividends to Minimize Your Taxes
Let a Professional Help You Lower Your Taxes
Tax laws can be complicated. There are many different ways to structure your investments so that you’ll owe as little to the IRS as possible. If you’d like to learn more about how your specific tax situation can be optimized, then please feel free to connect with us by sending an email or filling out our contact form.