Basics of IRS Rules on Gains and Losses
Knowing the Tax Laws can Save Money on Investment Income and Gains
Aug 24, 2009
The IRS rules require income tax to be paid on income derived from investments. In order to provide an incentive for individuals to invest long term in businesses, favorable tax treatment is given to some investments.
Gains and Losses on Sales of Investments
Gains from sales on investments (capital gains) are taxed at ordinary income rates, unless the gain meets certain criteria. Gains on investments held for one year or longer are currently taxed at the rate of 15%.
Losses on investments can be deducted from taxes. If there are capital gains, they can offset income up to full amount of the gain.
If capital losses exceed gains, they can offset other income up to a $3,000 limit in one year, married taxpayers filing separately can claim up to $1,500 each. Any excess losses can be carried forward to future years.
To calculate the gain or loss on sales, subtract the proceeds from the sale (net of commissions) from the cost to buy the investment (also net of commission).
Special rules apply to gains on sale of a personal residence.
Interest Income from Investing
Interest income is generated from fixed investments, where the taxpayer has no ownership in the company. Interest commonly results from bank savings accounts or Certificates of Deposits, and from bonds, both corporate and government.
Municipal bonds often are exempt from federal taxation. Other forms of interest are generally taxed as ordinary income, or the same as earned income. As a result municipal bonds will normally carry a lower interest rate than other bonds.
Interest earned on life insurance and other investments may be called dividends, but they are actually interest. Businesses paying interest greater than $10 are required to notify the individual with a form 1099-INT. Taxes are owed on all interest earned, whether the taxpayer receives 1099-INT or not.
Dividend Income from Investments
When an investor owns stock in a company, the company may pay dividend income to the stockholder. It is not a requirement and many companies do not, keeping the money to fund future growth.
Dividend income is taxable to the investor as ordinary income. For dividends for qualifying companies, the income is taxed at a lower rate than ordinary income.
Schedule B is required to be filed with the return if total dividends or interest exceeds $400 in one year.
Stock splits and stock divisions that do not result in income to the investor, but simply change the amount of shares owned, are not considered dividend income.
It is a smart strategy to take advantage of these appropriate methods of lowering income taxes. It is important to keep abreast of changes in tax laws, which are subject to modification by the IRS or Congress on short notice.
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