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How your investments are taxed for 2023: a guide • Benzinga

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If you invest money and then sell your investments, hopefully you will get a return. If you accumulate extra money, can you guess who else (besides you) will reach out to you? That’s right. Uncle Sam.

The type of investment income you receive will determine your tax treatment. If you incur losses on your investments, you may be able to deduct those losses. It is also possible to minimize your tax liability by investing in specific tax-advantaged accounts.

Understand the two types of dividends and how they are taxed

Dividends are payments to owners of stocks, exchange-traded funds (ETFs), or mutual funds. “Ordinary dividends” include both qualified and non-qualified dividends.

1. Qualified dividends

To be considered an eligible dividend, your dividend must be paid by a US company or a foreign company traded on a US stock exchange. You must hold a share for more than 60 days during the 120-day period beginning 60 days before the ex-dividend date. In the case of preferred shares, you must hold them for 90 days during the 180-day period beginning 90 days before the stock’s ex-dividend date. Qualified dividends are taxed at the capital gains tax rate. Learn more about capital gains taxes.

2. Non-qualified dividends

Ineligible dividends are taxed at the highest income tax rate, as they do not qualify for the lower rate. Some examples of non-qualified dividends and their equivalents include real estate investment trusts (REITs), master limited partnerships (MLPs), employee stock options, and money market accounts.

How short-term and long-term capital gains are taxed

When you sell your investments, you are taxed on the profits you make on those investments. This can also apply to other fixed assets, including cars, boats, land and real estate. How they will be taxed will depend on whether they qualify as short-term or long-term capital gains. Taxation only applies to realized capital gains, not unrealized capital gains (profits that only exist on paper).

Short-term capital gains refer to the sale of any asset held for less than one year and are generally taxed at taxpayers top marginal tax rate (your ordinary income tax rate) . Long-term capital gains refer to investments held for more than one year and tax rates are 0%, 15% or 20%, depending on the amount of income and reporting status.

How interest income is taxed

Interest income refers to income you receive by investing in bonds or cash investments and is based on your usual tax rate. Dividends, capital gains and interest income are reported on the 1099. See below for a complete list of 1099 forms:

  • 1099-B: Reports gains and losses based on the capital gains tax rate
  • 1099-DIV: Reports dividend income and capital gains distributions
  • 1099-INT: Report interest income
  • 1099-R: Reports retirement account distributions
  • 1099-MISC: Declares substitute payments in lieu of dividends
  • 1099-OID: Reports any original issue discount (OID) on debt securities
  • 1099-Q: Reports distributions from Education Savings Accounts (ESA) and 529 Accounts

How tax-advantaged accounts are taxed

Tax-advantaged accounts refer to any type of investment that is tax-exempt, tax-deferred, or provides other types of tax benefits. They are different from taxable accounts which most of the time do not offer the same tax benefits. These can include individual and joint investment accounts, bank accounts and money market mutual funds. There’s an entire personal finance division dedicated to sound tax planning, which encourages you to use the tax code to your advantage. Tax-advantaged accounts are a mainstay of what some even call tax hacking, without illegal activity. Here’s a quick roadmap to tax-efficient savings with these easy-to-implement options. For the most part, all you need is a brokerage account:

  • Roth IRA: Deposits are made with after-tax dollars, which means you pay no tax on your money when you withdraw your funds in retirement. However, there is a 10% penalty on early distributions on gross income earned.
  • Traditional IRAs: These IRAs are tax deductible and are treated as regular income for tax purposes if you withdraw at age 59½ or older. You will be penalized if you withdraw before this age.
  • 401(k), 403(b), Solo 401(k): You do not have to pay taxes on your funds until retirement. Note: Most early withdrawals (those made before age 59.5) are taxed as ordinary income, plus a 10% penalty.
  • 529 Education Savings Plan: States and educational institutions have created 529 tax-advantaged college savings plans for savers. When used for tuition, accommodation, board, and fees at qualified institutions, they are not subject to federal or (usually) state tax. More than 30 states offer a tax deduction for 529 contributions.
  • Health Savings Account (HSA): You can deposit money tax-free and withdraw funds tax-free when you use them for eligible medical expenses. Investment gains are also not taxed, provided you use them for eligible medical expenses. If you’ve reached retirement age, you can withdraw funds like a traditional IRA.

How capital losses are taxed

When the value of your investments declines, or more specifically, when you sell an investment for less than your purchase price or your adjusted basis, capital losses occur. If the stock market falls, you may recover some losses at tax time, but again, you will only reap the reward if you sell your assets. You can download the Schedule D form for capital gains and losses from the IRS website.

How dividend reinvestments are taxed

If you choose to reinvest your dividends instead of receiving them in payment, you will still have to pay tax on the dividends that were reinvested in that particular tax year. If you receive dividends in 2022, for example, you should receive a 1099-DIV statement. This includes dividends paid under a dividend reinvestment plan (DRP). A DRIP allows you to buy more shares rather than receiving a cash dividend.

What about tax-efficient investments?

For more information on tax-deferred accounts, taxable accounts, the best types of funds to hold in each, and the impact of taxes on portfolio growth, watch this video from TD Ameritrade.

Tax efficient strategies

Now you know that one of the most tax-efficient solutions is to build a smart wallet to protect your money from the government. However, many of these account types are illiquid, which can be disadvantageous if you need cash quickly. This is why taxable accounts are also part of most portfolios. Taxes are complicated, so it’s best to consult an accountant or tax advisor for more information on how you can build the most beneficial portfolio for your personal situation.

Frequently Asked Questions

Q

What if your capital gains are negative?

A

Negative capital gains occur when the sale price of an asset is lower than the purchase price, resulting in losses. This may affect the value of the investment portfolio and tax liabilities. It is important to manage investments carefully and consider strategies to offset negative gains. Counseling professionals can help mitigate negative impacts.

Q

Will I have to pay taxes on my investment income?

A

Yes, you will generally have to pay tax on your investment income. Specific tax obligations will depend on the type of investment and your country’s tax laws. You are advised to consult a tax or financial advisor to understand your specific tax obligations and how to properly report and pay taxes on your investment income.

Q

What is recovery of tax losses?

A

Tax loss harvesting is a strategy used by investors to minimize their tax liability by selling securities that have suffered a loss. This practice allows investors to offset capital gains from other investments and potentially reduce their overall tax liability.

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