Is Investment Income Taxed?

You’ve finally gotten your personal finances in order and have started saving or investing money. As you gain interest and/or receive dividends on that money, you’re excited to watch your money grow. That is, until tax season rolls around, and you receive 1099 forms that report those interest, dividends, and capital gains as income. Is your investment income really taxed?

Interest on Checking and Savings Accounts

If you have any sort of checking or savings accounts, the bank does pay you interest on that money. Depending on your interest rate, that money could be a couple dollars or a couple thousand. Whether or not you took that money out of your account, your bank will send you a 1099-INT in January to report how much interest they paid you and deposited into your account. This interest income is typically taxed at your regular tax rate.

Dividends Earned from Stocks or Mutual Funds

If you invest in any stocks or mutual funds, they may pay out dividends quarterly or yearly to stockholders. Again, depending on your investments, those dividends could be a few dollars or thousands and will be reported on a 1099-DIV from your bank or brokerage company.

If you’re thinking, “But I didn’t take any money out of my investments! Why am I being taxed?” You can have those dividends paid out to you, but you can also choose to reinvest them in the same stock or fund. Even though you reinvested the dividends and never saw it as cash, it is considered income that you received and were able to reinvest.

You’ll see two types of dividends on your 1099-DIV: ordinary and qualified. Ordinary dividends are taxed at your regular income tax rate, and qualified dividends are taxed at a lower rate.

Are Capital Gains Different from Dividends?

A capital gain (or loss) happens when you sell a stock or mutual fund. If you sell it for more than you paid for it, it’s a gain and, therefore, considered income. In the year that you sell and have a gain, your bank or brokerage will send you a 1099-B form.

Income from capital gains is taxed in one of two ways:

• Short-Term gains are investments that you held for one year or less and are taxed at your regular tax rate.

• Long-Term gains are investments that you held for more than a year and have different tax rates of 0%, 15%, and 20%. The rate you get taxed at will depend on your filing status and income.

Don’t Forget to Deduct a Capital Loss

If you sold a stock for less than you paid for it, you have a capital loss on your hands. If that happens, you can deduct that loss on your tax return up to $3,000. If the loss is more than $3,000, you can carry over the remainder the following year.

It may be frustrating to have to pay taxes on your investment income, but the good news is that it means your money is making money for you.