As a new investor, understanding the tax rules around portfolio income and realized gains can be confusing. Nonetheless, it's important to have a basic understanding of how it works. It can help you make better investment decisions and increase after-tax income.
Additionally, this knowledge makes tax season a whole lot easier when you need to report investment income to the IRS.
The good news is, you're not alone. If you have a Firstrade account, they will issue you helpful reports every year to use for your tax filing.
Before looking at how to properly report to the IRS, let's look at an overview of the different forms of investment income taxes. There are a few different types of taxes to be aware of.
Also, remember that these taxes only apply to taxable investment accounts. Retirement accounts like IRAs and Roth IRAs do not have to pay these. Be sure to consult with a tax professional or do further research if you have questions regarding your situation.
A gain is defined as the net profit you receive upon the sale of an investment. For example, if you buy a share of XYZ company for $50 and later sell it for $100, you have $50 of gains to report. It's important to note that there is no income to report unless you actually sell the investment.
The government wants to encourage taxpayers to hold investments long-term. Because of this, investors are subject to a lower tax rate if they wait to sell their investments for over one year. This is called a long-term capital gain.
Currently, long-term capital gains are taxed at a favorable flat rate of 0%, 15%, or 20%, depending on your total income.
You can also realize capital losses which will lower your total capital gain for the year. This is important for the more advanced strategy of tax-loss harvesting.
If you buy and sell an investment before a year has passed, you will have a short-term capital gain. These gains are treated the same way as ordinary earned income. The amount will be added to your regular income, like from a job, and taxed at the same rate.
For this reason, holding investments for at least one year can be a strategic way to lower your tax bill. The higher the tax bracket you are in, the more beneficial it is to hang onto your investment for over a year.
Throughout the year, your investments will likely receive dividends and/or interest payments. This income is typically seen as cash deposits into your account which you can use to reinvest or withdraw. Firstrade will keep track of this income as it arrives in your account.
Ordinary dividends and interest are taxed like ordinary income, similar to short-term capital gains.
Qualified dividends, which come from companies that you are holding long-term, are taxed like long-term gains at a favorable rate.
Keep in mind, if you try to sell an investment to realize a loss and then buy it again within 30 days, you've created a wash sale. Wash sale rules were created to prevent investors from realizing losses and continuing to hold the asset.
If you want to realize a loss, make sure to buy shares of a different company/fund or wait to buy back in for at least 30 days.
Reporting these income sources isn't as time-consuming as you may think. At the end of the year, Firstrade will compile all of the information you need into a few types of tax reports.
These forms usually become available in late January or February and can be downloaded electronically. Sometimes, you can even directly import the reports into a tax reporting service like Turbotax or H&R Block.
When you go to file your taxes for the previous year, be sure to have the forms above on hand. All the information you will be asked for regarding your investments will be available on them.
Firstrade is an online investment platform established in 1985. Firstrade charges no commissions or fees on transactions of stocks, ETFs, and mutual funds. Their service features a wealth of research tools and educational support.
Plus, Firstrade is known for its ease of use which makes it a good option for beginners.
For more advanced traders, Firstrade also has extensive options trading capabilities. They even offer users the ability to unlock professional-grade tools if necessary.
If you're interested in opening an account, Firstrade has no account minimums and you can choose to open a retirement account in addition to regular brokerage accounts.
Taxes are an important aspect of investing. Being familiar with tax rules can help you increase your after-tax rate of return by investing in a more tax-efficient way. Taking advantage of long-term capital gains rates can have a significant impact on the performance of your investments.
Keep an eye on your investments and be on the lookout for tax minimization opportunities.
While needing to report all investment income and sales can seem daunting, Firstrade makes things easy for you. The reports they generate for you every year compile all the information you need into one place.
Within the first two months of the new year, you should be able to download the different 1099 forms electronically and use them for your filing.
If you're reading this article, you're on the right track. Remember that it is always your responsibility to properly report your income, including that from investment activity.