Owning stocks, mutual funds, and other investments can make tax time a bit more complicated. While you may be aware of the taxes related to selling stocks, you may not know the other tax implications of an investment portfolio, such as what you may owe on dividends or interest earned.
Be prepared when you file your taxes, since you may need to pay taxes on your investments. Learn what you should expect this tax season if you have investments.
When Do You Pay Taxes on Stocks?
If You Buy or Sell Your Investments
If you sell some of your investments at a gain, you will have to pay taxes on the profits you made. This is called a capital gain.
Capital gains are taxed at different rates, depending on whether they are considered a short-term or long-term holding.
A short-term investment is one that you held for less than one year and is taxed at your normal tax rate of up to 37%, depending on your income. Meanwhile, a long-term investment is one you held for longer than one year and is taxed at 0%, 15%, or 20%, depending on your income.
If you lose money in your investments, this is called a capital loss. This also plays into your taxes.
You can deduct the amount you lost on an investment from your capital gains. That way, you'll owe less in taxes come tax season.
If You Earn Dividends and Interest
Even if you don’t sell any of your investments, you will likely still owe some taxes. For example, if you own stocks, a mutual fund, or an 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 will also have to pay taxes on interest earned. These vary based on the type of bond you own. If you own mutual funds, you will be responsible for paying taxes on any dividends earned. You will also have to pay taxes if you sold any mutual fund shares. However, you don’t have to pay taxes on any transactions performed by the mutual fund’s managers.
Plan Ahead to Pay Your Taxes
You can adjust your withholdings as you receive dividends, capital gains, and interest from your investment portfolio. This should help lessen the blow of your tax bill.
Another option is to put aside the money that you will owe in taxes on dividends, interest, and capital gains as you earn them.
If your current tax rate is 25%, you may earmark a quarter of any capital gains you received on short-term holdings to cover your taxes the following year.
You can also talk to your accountant about the best way to prepare for tax season if you have an investment portfolio, so you can be prepared to pay your tax bill—and still stick to your monthly budget.
Quick Tips for Filing Taxes
When it is time to file your taxes, 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 brokerage that shows your capital gains for that year.
If you work with an accountant or tax software, be sure to be organized and have all the forms you’ve received for that tax year ready when you file. It helps to have a checklist of all forms to ensure you received everything you need to complete your taxes.
Ask an Accountant or Financial Adviser
How much you will pay in taxes on your investments will vary depending on the number of investments you have, if they made or lost money last year, your current income, and other financial factors. It is important to consult with 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 make a big impact on your tax bill.
As your investments grow, so will your taxes, 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 adjust as your tax burden increases. When you reach a point where you are earning a significant amount in investments each year, it’s best to hire an accountant to help you come up with a workable tax strategy.
Try These Tax-Advantaged Investment Vehicles
Now that you know about paying taxes on investments such as index funds, mutual funds, and stocks, it may be time to take advantage of a tax-free investment account. Examples include: