Reporting regular and investment income

The Internal Revenue Code requires the reporting of various types of investment income that derive from many different sources.  The most common for the average taxpayer are interest, dividends, and capital gains.  Interest and dividends are treated as ordinary or regular income, unless they are specifically excluded from taxation, such as municipal bonds. 



The capital gains tax is a tax charged on the sale of a capital asset that was originally bought for less than the sale price.  Short-term gains (less than one year) are taxed at a different rate than long-term gains (more than one year).  Capital assets include your house, furniture, car, stocks, and bonds.  Interest and dividends are reported on IRS Schedule B and capital gains are reported on Schedule D.  Other investment income such as rental properties and partnerships are reported on Schedule E.


Video: 5 Things to Know about Taxes and Your Investments


Income the taxman can’t touch


With proper planning, there are ways to shelter investment income from federal income taxes.  The interest on municipal bonds issued by a city or state is exempt from taxation.  If members of a carpool reimburse you for your operating expenses, this is not reportable income.  You can exclude up to $250,000 ($500,000 joint return) in capital gains on your principal residence if you lived in it for at least two of the last five years.  Another way to indirectly increase your income is through employer-sponsored education.


taxes on investments


It benefits both you and your employer if the employer pays part or all of your health and life insurance premiums instead of giving you a pay raise of equal value.  The employer avoids the salary increase and can write off the full cost of the coverage.  There are no payroll taxes on the premiums, and you effectively increase your income by the full amount of the employer contribution.  Flexible Spending Accounts allow you to pay for certain things with before-tax income.


Tax-deferred investments


Tax-deferred investments let you to keep more of the money you make investing by allowing you to pay federal income tax at the time you take the money out, rather than while the money is being invested.  Any earnings such as dividends or interest that accumulate during this period are also free from tax until withdrawn.  Some investments offer a further benefit which allows you to invest before-tax money which immediately increases the effective value of the investment by the amount of the tax savings.  The entire amount invested, plus earnings, will compound during the life of the investment.  Since these investments were created for the express purpose of saving money for the long-term, there are restrictions and penalties on early withdrawals.  If the money is withdrawn at retirement, you will most likely be in a lower tax bracket, which will further reduce your overall tax burden.


Video: Finance & Investment Tips: 401(k) Plan Benefits

There are popular employer-sponsored plans such as the 401(k) account.  In addition to the before-tax contributions, many employers also offer a matching contribution for a set percentage of your individual contribution.  The two types of Individual Retirement Accounts are known as traditional and Roth IRAs.  Traditional IRAs allow you to contribute on a before-tax basis as a function of your income.  The Roth IRA doesn’t allow before-tax contributions but specifies conditions under which earnings may be tax-exempt.  Also available are annuities which are contracts with a life insurance company with an accumulation phase and a payout phase.  Annuities provide death benefits and may also include other guaranteed payouts that are subject to some limitations.


How investment losses affect your taxes


Investment losses generally reduce your tax bill by offsetting income and other investment gains.  Capital losses may be used to offset all capital gains in the same year and up to a maximum of $3,000 in ordinary income.  The balance of all capital losses may be carried over to the next year to offset future capital gains.  Because of these rules, it is sometimes to your advantage to time your capital losses in order to reduce or eliminate the taxes on your gains.  Losses declared on Schedule E may be subject to limitations based on whether or not they are active or passive losses.  This applies to real estate rentals which require active participation in order to take full advantage of the potential tax write-offs.


Tax code changes that affect investors


Contribution limits in 2009 for 401(k) plans increased from $15,500 to $16,500.  Limits for Savings Incentive Match IRA plans for employees of small businesses increased from $10,500 to $11,500.  For Roth IRAs, the income phase-out threshold now starts at $166,000 for joint filers and $105,000 for those filing as single or head of household.  For a tax-deductible traditional IRA, the income phase-out limits start at $89,000 for joint filers and increases to $55,000 for those filing as single or head of household.  While you can’t deduct a loss from the sale of your home, any forgiven debt resulting from a restructured mortgage is no longer taxable.  The tax rates for capital gains have undergone numerous changes and the latest information is available from the Internal Revenue Service.


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