How to understand investment taxes

Following these helpful tips will keep you smiling during tax season. Credit: Getty Images
Following these helpful tips will keep you smiling during tax season.
Credit: Getty Images

With tax season right around the corner, many people have questions about investment taxes. They are important to think about, but too often people shy away from investing because they’re worried about taxes. But once you understand how they work, you’ll see that investing can be a smart way to save money.

First, there is a difference between ordinary income tax (that’s the tax that is imposed on the salary you earn) and investment income tax (the tax you pay on money you make through the market returns). Investment income includes interest generated by bonds and dividends paid on stocks. When you sell such an investment for more than you bought it for, the difference is called capital gains, and is generally subject to capital gains tax.

Capital gains come in two buckets: there are short-term capital gains and long-term capital gains. Long-term capital gain results from selling investments held for more than a year, and, for now, is taxed at around 15% for the majority of taxpayers.  This tax rate is relatively low as a way to incentivize taking some risk that naturally comes with investing.

Short-term capital gain refers to income earned on an investment held for a year or less. This gain is taxed at a relatively higher rate (similar to ordinary income tax), which is the government’s way of discouraging investors from flipping investments.

Individual circumstances vary, but here are some quick guidelines that apply to all but pretty unusual situations. If you can learn these guidelines to investment taxes, you’re in good shape.

  • Every kind of savings or investment account has taxes: You pay income tax on all realized investment income, whether it’s interest in a savings account, or dividends in your investment portfolio.

  • There are no circumstances under which you’ll be taxed more on a dollar of growth on your market investments than in a savings account. There are circumstances under which you’ll pay less tax on the same return in your investments, compared to a savings account.

  • You only pay capital gains tax when you sell an investment which has risen in value. If it falls in value and you sell it, you get a capital loss which can offset other gains, and you owe no tax.

  • You pay tax only on the gains, not on the full amount invested. If you invest $100, and it grows to $140, you’ll only owe tax on the $40.

  • Though the exact rate depends on your income and marginal tax rate, the most the federal government would tax you on gains from short-term investments (held for a year or less) is your ordinary income tax rate (plus 3.8% for more affluent taxpayers).

  • If it’s a long-term investment (held for more than a year), you’ll owe between 0% and 23.8% federal tax on the gain.

Note that individual circumstances may vary, and the above should not be construed as tax advice. Always consult your tax advisor.

Jon Stein is the founder and CEO of Betterment, a leading online investing company that delivers smart, personalized financial advice paired with low fees and a superb customer experience. As a special offer, Metro readers can start a Betterment with the first 90 days free. Got money questions? Hit us up at metro@betterment.com.



News
Entertainment
Sports
Lifestyle
Local

Mayor announces public housing improvements

Mayor Bill de Blasio spoke at the Lincoln Houses in East Harlem on Wednesday, calling for the scaffolding to come down at NYCHA complexes across…

National

Peter Theo Curtis: American released by Syrian militants…

An American writer freed this week from two years in the captivity of insurgents in Syria spoke briefly outside his family's Cambridge home Wednesday of…

Local

Bratton defends 'broken windows' work as NYPD support…

Sixty percent of those polled said they support the "broken windows" theory approach popularized by Commissioner Bratton since his first term in the 1990s.

Local

Transit changes for Labor Day weekend

The MTA is adding additional service Friday for New Yorkers getting out of the city for the long weekend. On Friday, Aug. 29, 27 additional…

Television

'Full House' might be relaunched with some of…

A new "Full House" might be in the works.

Movies

Review: 'The Congress' is a crazy, unwieldy sci-fi…

Robin Wright is the center of gravity in "The Congress," which turns from a live-action Hollywood satire into an animated spectacular on a downer future.

Movies

Review: 'The Last of Robin Hood' is a…

Dakota Fanning plays Errol Flynn's (Kevin Kline) teenage gal pal in "The Last of Robin Hood," which takes a scandal and makes it dully empathetic.

Movies

Review: The uneven 'Life of Crime' mostly gets…

Elmore Leonard's "The Switch" becomes the new indie crime dramedy "Life of Crime," with Jennifer Aniston as a kidnapped woman whose husband won't pay up.

College

When are 2014 college football playoffs? (Schedule, date,…

When and where are 2014 college football playoffs? A look at the schedule, date, TV, time for the semi-finals at championship game.

NFL

Dimitri Patterson suspended only for rest of preseason…

Dimitri Patterson ended up getting just a slap on the wrist.

Sports

Eugenie Bouchard excited for 'rowdy' fans at US…

Eugenie Bouchard is sure to endear herself to New York's tennis faithful as she tries to win her first grand slam title across the next two weeks.

MLB

MLB Power Rankings: Angels and A's still at…

MLB Power Rankings: Angels and A's still at top, Nationals climb

Home

Labor Day essentials

Whether you’re soaking up the sun on the beach or barbecuing in the park here are some must-haves for your end-of-summer bash.

Education

Does the school day start too early?

As thousands of high schoolers get ready to head back to class, health experts say it may be time to push back the start of…

Style

Fall 2014 trend: lilac

Push those gray and black sweaters aside and make room for blush and lilac.

Career

Stop eating lunch at your desk

What are you doing for lunch today? If you are like most workers, you'll be eating at your desk - which isn't much of a…