Owning stocks, mutual funds, and other investments can make tax time a little more complicated. While you may be aware of the taxes related to selling stocks, you may not know the other tax implications of your investment portfolio, such as the amounts you might owe on dividends or interest earned.
When do you have to pay taxes on stocks?
Since holding stocks can earn income, any action that brings you money may have tax implications.
If you buy or sell your investments
If you sell some of your investments for a profit, you’ll need to pay taxes on the gains you’ve made. This is called capital gains.
Note: Capital gains are taxed at different rates, depending on whether they are considered short-term or long-term investments.
A short-term investment is one that has been held for less than a year and is taxed at ordinary rates of up to 37%, depending on your income. In contrast, a long-term investment is one that has been held for more than a year and is taxed at rates of 0%, 15%, or 20%, depending on your income.
If you lost money on your investments, this is referred to as a capital loss. This also affects your taxes, and it may be beneficial for you. If your losses exceed your gains, you can use them to reduce your taxable income, up to a certain annual limit. In many cases, you can also carry any excess capital loss to the next year.
Note: You can deduct the amount you lost on an investment from your capital gains. That way, you’ll owe less in tax season.
If you are receiving dividends and interest
Even if you haven’t sold any of your investments at a profit, you may owe some taxes on them because of the money you earn passively. For example, if you own stocks or a mutual fund or index fund, you may receive periodic payments from that company. These payments are called dividends, and you have to pay taxes on them.
Additionally, if you own bonds and earn interest on them, you’ll also have to pay taxes on the interest earned. These taxes differ depending on the type of bond you own. If you own mutual funds, you’ll be responsible for paying taxes on any interest you earn. You will also have to pay taxes if you sell any shares in the mutual fund. However, you do not have to pay taxes on any transactions made by the mutual fund managers.
Pre-planning your tax payments
You can adjust the taxes withheld from your income when you receive dividends from the income and interest generated by your investment portfolio. This should help reduce your tax bill amount.
Another option to reduce the amount you pay in taxes on investments is to set aside the money you will owe for taxes on dividends, interest, and capital gains when you earn it.
Note: If your current tax rate is 25%, for example, you might allocate a quarter of the capital gains you’ve received from short-term investments to cover your taxes for the following year.
You can also talk to your accountant about the best way to prepare for tax season so that you are ready to pay your tax bill while still adhering to your monthly budget.
Quick tips for filing taxes
When tax filing time arrives, you should receive a 1099-DIV form from each company or fund that sent you dividends. You will also receive a 1099-B form from your investment broker showing your capital gains for that year.
If you’re working with an accountant or tax software, make sure that you are organized and have all of the forms you received for that tax year ready when you file your return. It’s helpful to have a checklist of all the forms to ensure that you’ve received everything you need to complete your taxes.
Consult
Accountant or Financial Advisor
The amount you will pay in taxes on your investments will vary based on the number of investments you own, whether they have generated profits or losses in the past year, your current income, and other financial factors. It is important to consult your accountant and financial advisor about how much you need to save to cover your taxes each year.
If you are just starting to invest, what you earn may not be enough to significantly impact your tax bill.
Note: As your investments grow, your taxes will increase, and you need to be prepared to handle the changes and subsequent tax bills.
In most cases, the changes will come gradually, and you should be able to adapt to your increasing tax burden. When you reach a point where you are earning a substantial amount from investments each year, it is advisable to hire an accountant to help you create a feasible tax strategy.
Considering Tax-Exempt Investment Options
Now that you know about paying taxes on investments such as mutual funds and stocks, it’s time to take advantage of a tax-free investment account. Examples include accounts like 401(k), 529 college savings plans, Health Savings Accounts (HSA), and Individual Retirement Accounts (IRA) or Roth IRA.
Frequently Asked Questions (FAQs)
How much tax do I pay on stocks?
Your investment income can be taxed at different rates, depending on how the income is classified and what your total income is from all sources. Short-term capital gains (from investments you held for 12 months or less) and ordinary income are taxed at your regular income tax rate based on your tax bracket. Long-term capital gains are taxed at lower rates.
How do I report investment earnings to the IRS?
At the beginning of the tax year, you will receive tax forms – usually Form 1099-DIV – that contain any earnings from dividends or sales. You will use these forms to report your stock earnings on your annual tax return, and you will calculate taxes based on the type of earnings you received.
Can I avoid paying taxes on stocks?
It is illegal to evade paying taxes on applicable taxable income. However, there are many ways to strategically invest to reduce the tax burden on your stocks. Some of the best ways to do this include holding stocks for longer periods, investing through tax-deferred retirement accounts, using capital losses to offset gains, and more. Speak with your advisor about how to minimize taxes on your investments.
Source: https://www.thebalancemoney.com/how-will-owning-stocks-affect-my-taxes-2385920
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