Financial experts would recommend you to start investing if you want to boost your income further. However, you need to understand that your investments are subjected to tax as well.
Tax-Related Things You Need to Know About Your Investments
Here are some common questions about investments and tax:
What are dividends?
Companies can either reinvest excess capital into new profitable projects or return the money to their shareholders in the form of dividends. Dividends are often distributed on a monthly, quarterly, or semi-annual basis.
However, not all stocks pay dividends. For instance, value stocks like banks and utilities do offer to pay consistent dividends, while growth stocks pay little or no dividends to their shareholders as the money is used for new financial ventures with high potential.
Taxes on Dividends
You are liable for income tax whether you receive your dividend in cash or reinvestment.
You will be taxed every time you receive a dividend if you hold your dividend-paying investment in a taxable brokerage account. On the other hand, you will only owe tax when you withdraw your money if you put your dividend in tax-deferred accounts.
What are Capital Gains?
Capital gains refer to the amount of money you earn when you sell a stock. It is the amount above the original price of the stock when you bought it. For instance, if you bought a stock at $5 per share and you are able to sell it for $10, then you have a $5 capital gain.
Tax on Capital Gains
There are two types of capital gains: realized and unrealized capital gains. Realized gains are considered as income, which means you need to pay taxes from it. Unrealized gains are also known as paper gains. It is when you have capital gains but you do not sell your shares. You can minimize the tax on your capital gains by holding your positions for as long as you can within reason, as an effect– your future gains will have favorable tax treatment.
Other Taxable Investments
Here are other taxable investments that you need to know about:
Sale of Real Estate
Selling your home gives you the opportunity to gain over the purchase price of your home, and this is considered as a capital gain for income tax purposes.
You can shield some of your capital gains if you pass certain IRS criteria:
- You need to have owned the house for at least two years.
- You need to have lived in the house for at least two years in the past five years.
If you pass these criteria then you can shield up to $250,000 if you are single and up to $500,000 if you are married. However, this only applies if the house you are selling is your primary residence. If you have rental properties or other real estate investments then you won’t be able to exclude your gains from tax should you sell them for a profit.
Interest income comes from bond investments. This type of income is taxable just like your regular income. Unfortunately, this type of investment does not give you the opportunity to take advantage of lower long-term capital gains rates unlike with qualified dividends or realized long-term gains from investing in stocks.
You can still minimize the taxability of your interest income by holding it in tax-deferred or tax-exempt accounts. Although you still need to pay your taxes upon withdrawal, at least your interest does not get taxed as it is received.
Paying taxes is inevitable. Do not focus on tax avoidance–create a tax management strategy instead! If you are paying taxes, then it means that you are earning because you are doing something right. Appreciate the fact that your investments are performing well and then work on a tax plan that will help ease your burdens.