Author Topic: Need intro on how investment taxation works (US)  (Read 1892 times)

Beowulf

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Need intro on how investment taxation works (US)
« on: October 30, 2014, 09:09:42 PM »
Can anyone show me a very basic guide to how taxes on investments work in the US?  In particular what sort of withholding do I need to do and does Vanguard do it for you?

seattlecyclone

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Re: Need intro on how investment taxation works (US)
« Reply #1 on: October 31, 2014, 11:43:17 AM »
There are a few types of income from investments.

First, there are capital gains. If you buy a share for $100 and sell it for $300, you'll pay tax on the $200 of gain. This is taxed at your normal income tax rate if you held the stock for a year or less, or at a lower rate if you held it for more than a year.

Then there are dividends. Many stocks and stock funds pay these. If you own the stock long enough (for a majority of the 121-day period surrounding the dividend date), these count as "qualified dividends" and the tax is at the same low rate as you pay for long-term capital gains. Otherwise the dividend is taxed at your regular income tax rate.

If you own bonds or REITs the payments you receive from these do not count as qualified dividends. You always owe regular income tax rate on these.

If you're in the US, brokers generally don't do withholding. You'll need to either increase the withholding out of your paycheck by enough to pay these taxes, or send the IRS estimated taxes to cover the amount.

All of this is for investments in a taxable account. If you invest in a retirement account, you don't pay any of these taxes right away. It's all taxed when you withdraw the money (for a "traditional" retirement account) or when you put it in (for a Roth account), but never in between.

skyrefuge

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Re: Need intro on how investment taxation works (US)
« Reply #2 on: October 31, 2014, 12:12:30 PM »
If you're in the US, brokers generally don't do withholding. You'll need to either increase the withholding out of your paycheck by enough to pay these taxes, or send the IRS estimated taxes to cover the amount.

And just to provide a maybe-totally-misleading data point, I have a little less than $1M (or maybe more than $1M with today's market!) in invested assets, with about $400k in taxable accounts, and I've never had to pay estimated taxes to the IRS (excluding the period when I was self-employed), nor have I done anything special with my withholding. Only recently have I started owing a bit at tax time, but not so much that I'm hitting the trigger that requires estimated taxes to be paid. Of course, the investments in my taxable accounts are largely tax-efficient stock funds (specifically "Tax-Managed" Vanguard funds), so I'm sure that helps.

Anyway, my conclusion from a single data point is that most people don't have to do anything special to prepare for investment taxes, though I suppose a poll could give a broader picture!

Sid Hoffman

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Re: Need intro on how investment taxation works (US)
« Reply #3 on: October 31, 2014, 05:28:28 PM »
First, there are capital gains. If you buy a share for $100 and sell it for $300, you'll pay tax on the $200 of gain. This is taxed at your normal income tax rate if you held the stock for a year or less, or at a lower rate if you held it for more than a year.

Long-term capital gains is potentially taxed at a MUCH lower rate.  If you're in the 15% marginal bracket, LTCG is 0%.  It's hard to beat paying no taxes!  LTCG if you're in the 25-35% marginal bracket is taxed at 15%, and if you're in the top 39.6% tax bracket, LTCG is taxed at 20%.  So even worst case scenario in the top bracket you are paying half the taxes by keeping the property/equity for a full year than if you sold in less than a year.

 

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