Investment Income. Many of us happily receive it, but not everyone knows how to deal with the tax implications that may surround it, as there are multiple types and how they are classified and taxed are very different. Some sources of investment income may be in the form of interest from more conservative holdings such as high yield savings accounts and CDs or treasury bonds, or it may come from traditional stock and bond holdings. Sales of other assets such as real estate, land, and collectables, can also incur taxable events. Digital assets are also much more mainstream than in previous years, and they are making appearances on tax returns more often.
High yield savings accounts, CDs, any bank savings accounts, and income from bonds would typically produce interest income, which would be shown to you in the form of a 1099-INT or a brokerage’s 1099 Consolidated. This income will be taxed at whichever rate your ordinary income will be, which is federally marginalized at 10%, 12%, 22%, 24%, 32%, 35%, and 37%. This means that your income will gradually be taxed at these rates – once it is at a rate, only the portion of income that is above the threshold for each is taxed at each; this does not mean that all of your income is taxed at your highest rate. Statewide, the same concept applies and it will be applicable to your state’s ordinary income tax rate, if your state has one. Treasury bond interest is treated similarly federally, but they are not taxed statewide, and municipal bonds are not taxed federally but will likely be taxed within your state and locality. These are some of the most straightforward and conservative means of acquiring investment income, as they provide simple and relatively predictable inflows.
Dividends are produced from distributions of corporate profits, and there are two main types: Ordinary and Qualified, and they are treated differently in the taxable context. Ordinary dividends are taxed at the same marginal rates as interest income. Qualified dividends however, if the security providing the dividend is held for more than 60 days, are taxed at preferential long term capital gains rates, which will range from 0% to 15% to 20%. Dividends will be accounted for and provided to you within a 1099-DIV or a brokerage 1099 Consolidated form.
Capital Gains are another very common taxable event that will occur when holdings such as stocks, real estate, land, or collectables, are sold at a net gain. Long-term gains are taxed at preferential rates (held for more than 1 year) and short-term gains are taxable at ordinary income rates (held for less than one year and sold). There are certain rules regarding capital gains that allow for an avoidance of paying some or all of the amount, such as selling a primary residence you have lived in for at least two years. If you file single, the first $250,000 of gain on the property is not taxable, and if you are married filing jointly, up to $500,000 is not taxable. Tracking the cost basis when selling homes can provide the means to properly account for these exceptions. Collectables, such as gold, silver, antiques and art are subject to a maximum 28% long term gain rate, which gives them a unique disadvantage. Capital gains will be provided to you via a 1099-B, which also may be within a 1099 Consolidated statement.
Digital assets are considered to be a “new financial frontier” for some, and are growing in popularity, particularly among young filers. Digital assets include cryptocurrencies, NFTs, tokenized assets, and stablecoins. If you own and sell any of these, you should be provided a 1099-DA, which will be used to report gross proceeds from the sales, account for asset swaps, and show any payments you may have made with digital currencies. When filing your Form 1040 return, there will be a box to check that will be asking if you sold digital assets.
As you can see, there are a handful of various investment income sources, and each will be taxed in different ways. Always reach out to a trusted financial advisor or accountant if you have any uncertainties in understanding the nature of investments and the income that they will likely provide for you.