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Taxes and Investments

Taxes and Investments!

          So we have discussed the importance of diversification and correlation in terms of their role in investing. Now, we will examine investing from a different perspective: the significance of taxes! Why taxes? Even though taxes should not be the driving force behind an investment strategy, it is prudent to take advantage of opportunities to manage, defer, and reduce taxes.

Type of Taxes

Capital Gains Tax

What is it? Gains from the sale of an asset, such as shares of stock, a piece of land, or a business, are typically considered taxable income.

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When would it come up? The proceeds from the sale of any asset constitute capital gain. For instance, if you sold an asset for a profit of $5,000 this year, you may be required to pay capital gains tax on the gain. The tax rate you pay depends on how long you held the asset before selling it. The capital gains tax rate for the majority of assets held for more than one year is 0%, 15%, or 20%. However, The majority of assets held for less than a year are subject to ordinary income tax rates on capital gains.

Offset or Minimize it? Investors may deduct capital losses against capital profits generated in the same tax year or carried over from prior years (Tax-Loss Harvesting). Individuals may deduct up to $3,000 annually in net capital losses against other taxable income. Any losses exceeding the tolerance may be used to offset future profits.

Tax-Loss Harvesting is a method of reducing current taxes paid to the U.S. federal government by selling an investment at a loss (incurring a capital loss) in order to offset taxes payable on an investment sold at a profit (capital gain) or even taxes owed on personal income. However, The IRS considers the sale and repurchase of a “substantially identical” security within 30 days to be a “wash sale“, which the capital loss cannot be deducted within the current tax year.

Dividends Tax

  • What is it? Dividends are taxed in the year they are received. Even if the dividend was automatically reinvested to purchase additional shares of the underlying stock, such as through a dividend reinvestment plan (DRIP), you are still required to declare the dividends and pay the tax.

  • Tax Rate? There are two types of dividends: qualified and nonqualified. The same tax rate applies to nonqualified dividends as your ordinary income. However, the tax rate on qualifying dividends is lower: Depending on your taxable income and filing status, the rate is 0%, 15%, or 20%.
  • Qualified or Nonqualified? The dividend must be paid by a U.S. corporation or a foreign company that trades in the U.S. or has a tax treaty with the U.S. to be qualified. Nonqualified dividends include dividends from foreign companies that do not meet at least one of the following three requirements: 1)the company is eligible for the benefits of a comprehensive income tax treaty with the U.S., 2) the corporation is incorporated in a U.S. possession, or 3) the stock is readily tradable on an established U.S. securities market.

Interest Tax

What is it? Bonds are normally taxed in two ways: when interest is earned and when they are sold for a profit. However, taxation depends on the kind of bond you purchase.

Tax Rate? The federal government treats most interest as ordinary income tax. There is an exception… interest on bonds issued by the U.S. are exempt from state and local tax. Municipalities are exempt from federal income tax in the vast majority of cases and if you purchase municipal bonds issued by the state in which you submit state taxes, the interest you receive is often free from state income taxes as well.

Type of Tax

What is it?

Tax Rate

When does it Incurred?

Short-Term Gain

Sale of any asset results in capital gain

Ordinary Income Tax Rate

Held 1 year or less

Long-Term Gain

Sale of any asset results in capital gain

Depends on your taxable income and filing status, it is 0%, 15%, or 20%

Held for more than 1 year

Nonqualified Dividend

Dividends are taxed in the year they are received and do not meet at least 1 of the 3 requirements

Ordinary Income Tax Rate

In the year received

Qualified Dividend

Dividends are taxed in the year they are received and is a U.S. or foreign company that meets the requirement

Depends on your taxable income and filing status, it is 0%, 15%, or 20%

In the year received


When Interested is earned on the bond and when the bond is sold for captain gains

Ordinary Income Tax Rate

In the year earned

What Else for Taxes?

Investment Interest

You may be eligible for a tax deduction if you borrow funds to purchase an investment. Using Form 4952, the IRS permits some taxpayers to deduct the interest expense on certain loans. The tax implications of investment interest may be complex, since the IRS only allows a deduction for specific forms of investment interest. In addition, the Alternative Minimum Tax (AMT) may bar the investment interest deduction entirely

So, how does it work? You may only deduct investment interest expenses to the extent that they are less than or equal to your net investment income. For instance, if you have $3,000 in margin interest but only $1,000 in net investment income, you may only deduct $1,000 in investment interest in the year. However, the IRS permits you to carry over the disallowed deduction to future tax years. In this case, you may utilize the $2,000 in disallowed costs from this year in a subsequent year, but the same limitations apply. To deduct investment interest, you must have net investment income.

However… Not all of the interest you pay on investment loans is deductible. Certain forms of investment interest are expressly disqualified by the IRS, including the following: qualified home mortgage interest, the interest used to generate tax-exempt income, such as if you use margin to purchase a municipal tax-free bond, option straddles, and interest considered when computing the gain or loss from any passive activities are not deductible.

Lastly, Alternative Minimum Tax (AMT) will come into play because you must always submit a second Form 4952 for AMT calculations. The AMT is intended to guarantee that some individuals pay a minimal amount of tax by reincorporating items that may have been omitted from a conventional tax computation.

Advisor Fees        

  • Fees for investment management and financial planning were tax-deductible until the 2017 tax year. They belonged to the category of miscellaneous itemized deductions, which were removed by the Tax Cuts and Jobs Act (TCJA) beginning with the 2018 tax year. However, the TCJA is due to expire at the end of 2025 unless Congress extends it, so it is possible that this deduction might return.

Going Forward… While tax-efficient investing shouldn’t be difficult, it does need some preparation and planning. While many investors worry about market volatility and inflation, it is still important to remember that a better understanding of your tax situation might increase your after-tax earnings. Investment selection, the timing of purchase and sell choices, account selection, taking advantage of realized losses, and particular techniques like charitable giving are just some of the levers that may be pulled in an effort to control, delay, and decrease federal income taxes.

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All investors are unique.  The above characteristics are examples, but may not reflect your particular investor demographics or situation.  An advisor with Edgar Investment Management, LLC will assist you with finding the best type of account for you. 

Investment advisory services are offered through Edgar Investment Management, LLC, an investment advisor registered with the State of Texas. Edgar Investment Management, LLC only offers investment advisory services where it is appropriately registered or exempt from registration and only after clients have entered into an investment advisory agreement confirming the terms of engagement and have been provided a copy of the firm’s ADV Part 2A brochure document.

The content found on this website is developed from sources we believe provide accurate information and is for educational purposes only. The information on this website is not intended as tax or legal advice. Everyone’s tax and legal situation is different, so please consult trusted and knowledgeable legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided on this website are for general information, and should not be considered a solicitation for the purchase or sale of any security.

Material and information found on this website is not intended as an offer or solicitation for the sale or purchase of any specific security, mutual fund, ETF, bond, or investment strategy.  

Investing is risky!  No guarantee as to performance of any investment is implied by this website.  Make sure you have evaluated your options and spoken with trained professionals before you implement any investment strategy.  Past performance is not indicative of future results.  

Please be advised that Edgar Investment Management, LLC is a financial advisory firm specializing in investment management and financial planning services. We do not offer or provide any CPA-related services, including tax preparation, tax planning, or other accounting services. If you require assistance with tax-related matters, we recommend consulting a qualified CPA or tax professional who can provide specialized advice tailored to your individual needs.

Edgar Investment Management, LLC is not a Public Accounting firm.


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