Taxes on Investments: What to Expect When Filing

If you’re new to investing, it’s important to know the tax implications of your investment income before it’s time to file. For starters, you should know that most investments are taxable, except for 401(k)s, IRAs, and HSA accounts. Additionally, two crucial times when your investments affect your taxes are when you receive income from your investments and sell them.  

In this article, we’ll break down the factors that affect if and how you pay taxes on your investments. 

How is investment income taxed? 

Investment income includes money received from interest payments, dividends, capital gains realized with the sale of stock or other assets, and any profit made through other investment types. Depending on the type of investment, the IRS will tax your investment income according to your tax rate. In other cases, your investment income may get taxed at a lower rate (a maximum of 20%).  

Investments that follow this tax model include capital gains and dividends. Dividend distributions will be taxed differently depending on several specific requirements: 

  • The corporation distributing dividends must be based in the U.S. and 
  • The company’s stock must be publicly traded on major exchanges (Dow Jones, NASDAQ, etc.), or the company must be based in a country that has a double-taxation treaty with the U.S. and 
  • You must own the dividends for at least 60 out of 121 days   

Your tax rate on qualified dividend distributions depends on your taxable income and filing status – we’ve broken the rates below: 

Qualified dividend distribution tax rates for tax year 2023 (returns filed in 2024) 

Filing status 0% Tax rate 15% Tax rate 20% Tax rate 
Single up to $44,625 $44,626 – $492,300 over $492,300 
Married Filing Separately up to $44,625  $44,626 – $276,900  over $276,900 
Married Filing Jointly up to $89,250 $89,251 – $553,850 over $553,850 
Head of Household up to $59,750 $59,751 – $523,050 over $523,050 

Nonqualified (or ordinary) dividend distributions are quarterly payments made to shareholders that don’t meet the requirements for qualified dividends. Nonqualified dividend distributions are taxed using the standard federal income tax rates (10% – 37%). 

Tax on capital gains from selling investments 

A capital gains tax applies to the earnings of a non-inventory asset. So, think of items a company purchases for internal use, meaning they have no intention of selling that asset for a profit since the asset helps them run their business. Examples of non-inventory assets include cleaning and office supplies, maintenance services, and machinery.  

Say you purchase a top-of-the-line screen printer to get your custom t-shirt business started. If you decide to shut the business down and sell the printer, you will have to pay capital gains tax on the printer if its value appreciated between the time you bought and sold it. 

If you’re not running a small business, non-inventory assets would be things you own for personal use that generate income – items like homes, vehicles, and designer goods would be subject to capital gains tax if the items’ value appreciated during your period of ownership.  

Your capital gains tax rate depends on your filing status, taxable income, and how long you owned the asset. If you own an asset for less than a year and sell it for more than you purchased it for, this would be considered a short-term capital gain. If you hold an asset for longer than a year before you sell it for a profit, this would be a long-term capital gain.  

Short-term capital gains are taxed at the same rate as your taxable income, while long-term capital gains are taxed using a different tax table:  

Long-term capital gains tax rates for tax year 2023 (returns filed in 2024) 

Filing status 0% Tax rate 15% Tax rate 20% Tax rate 
Single up to $44,625 $44,626 – $492,300 over $492,300 
Married Filing Separately up to $44,625  $44,626 – $276,900  over $276,900 
Married Filing Jointly up to $89,250 $89,251 – $553,850 over $553,850 
Head of Household up to $59,750 $59,751 – $523,050 over $523,050 

For more information, read Taxes 101: Understanding Capital Gains and Losses

Capital gains tax on investment property 

If you’re selling your home or other investment property, you may be subject to capital gains tax if you’ve had the property for longer than a year and you’re selling the property for a profit. However, the Section 121 Exclusion allows you to exclude up to $250,000 (or $500,000 if you are filing jointly) of your capital gains from income taxes. Visit the IRS website to see if you qualify for this tax exception. 

If you sell after a period of short-term ownership, any earnings from the property would be considered a short-term capital gain. These capital gains are taxed at your federal tax rate.  

What is tax-loss harvesting? 

Tax-loss harvesting occurs when you sell nonprofitable investments at a loss to offset or reduce your capital gains tax liability from other investments. Investors typically use tax-loss harvesting to save on tax bills, grow investment portfolios by reinvesting their tax savings back into their portfolios, and reduce potential costs and risks of certain investments due to market volatility. 

If you decide to go the tax-loss harvesting route, you can deduct up to $3,000 of net capital losses against other taxable income each year. Losses more than the $3,000 allowance can be used to offset gains in future years. 

Before you engage in tax-loss harvesting, there are some rules to consider. First, you cannot utilize tax loss harvesting for 401(k) or an IRA because you can’t deduct losses generated in a tax-deferred account. Other restrictions exist on using specific types of losses to offset certain gains.  

For example, a long-term loss must be applied to a long-term gain – the same rule applies to short-term profits. If there are excess losses in one category, these can be applied to gains of either type.  

When conducting these transactions, it’s important to be aware of the wash sale rule, which occurs if you sell an investment at a loss and buy the same “substantially identical” asset back within 30 days before or after the sale.  

Taxes on interest 

Interest income is taxed at the same rate as your taxable income. So, if your income and filing status puts you in the 24% bracket, your investment income would be taxed at the same rate. 

There is an exception for taxation on bonds issued by U.S. states since these aren’t subject to federal income tax. You may also be exempt from paying taxes on state interest if you live in one of the nine states without income tax.  

How are mutual funds taxed? 

Mutual funds let you pool your money with other investors to mutually purchase stocks, bonds, and other securities held in a portfolio. Mutual funds generate short-term capital gains but are taxed as ordinary income, making a massive difference to your tax bill.  

We’ve discussed the difference between ordinary income and capital gains, but it’s worth repeating in the context of mutual funds. In the case of distributions from mutual funds, the difference between ordinary income and capital gains is how long the fund has held a particular investment in its portfolio rather than how long you’ve owned shares in the mutual fund.  

When you receive a distribution from a mutual fund that results from a sale of a security you’ve held for less than a year, it will be taxed at your federal income tax rate. But if you’ve had the security for over a year, your distribution will be taxed as a capital gain.  

Tax on retirement accounts 

Retirement accounts like 401(k)s and IRAs are taxed differently. The funds in 401(k)s are taxed before being deposited into your account, while IRAs are taxed when you withdraw the funds at retirement age. For more information about these retirement accounts, check out All About 401(k) Savings Accounts. 

FAQs about taxes on investments 

Have more questions about taxes on investments? Here are answers to common questions asked by our customers! 

How much tax do you have to pay on investments? 

Depending on the type of investment, you can expect to pay up to 20% on your investments according to your taxable income and filing status. We’ve included tax rates for capital gains and dividends in this article! 

How much interest income is taxable? 

Interest income is taxable at the same tax rate as your earned income. So, if your income and filing status puts you in the 22% bracket, your interest income would be taxed at the same rate.  

Do you pay taxes on investments if you don’t sell? 

No, investments only incur taxes when they are sold. So, if you bought an investment and kept it for five years before selling it in 2023, you will have to pay taxes on the investment’s long-term capital gains in 2024 when you file your taxes.  

Do you have to pay taxes on money withdrawn from an investment account? 

You don’t have to pay taxes on withdrawals if your money is in a brokerage account. If your money is kept in a 401(k), you must pay taxes on withdrawals held for longer than 60 days. 

Do you have to pay taxes on stock investments? 

It depends. If your investments gained value, you must pay capital gains tax on the investments when you decide to sell them. If your investments lose value, you don’t have to pay taxes when you decide to sell the stocks. 

Disclaimer:
This article is intended to provide general information to the public and does not provide personalized tax, investment, legal, or business advice. You should seek the assistance of a professional for advice on taxes, investments, and any other financial, legal, or business matter pertinent to your individual situation.