Reading 2022-03-31

Metadata

• Ref:: Investopedia
• Title:: Tax Basics for Investors
• Author:: Neil O’Hara
• Year of publication:: 2021
• Category:: Blog
• Topic:: #topic.investment
• Related::
  • Capital Gains Tax 101
  • ETF Tax in US
  • Income Tax in US
  • How Capital Gains and Dividends Are Taxed Differently
  • Long-Term Capital Gain or Loss
  • Ordinary Income
  • How Capital Gains and Dividends Are Taxed Differently
  • Income Tax vs. Capital Gains Tax: What’s the Difference?

Notes from reading

The federal government taxes

• not only investment income: dividends, interest, and rent on real estate
• but also realized capital gains 1

Investors that earn dividends or capital gains, by selling assets from their portfolios resulting in either a realized gain or loss, are subject to pay taxes on those gains

• Federal Income Tax on
  • Short-term capital gains and ordinary dividends are treated the same as income and taxed at the current income tax bracket level
  • Long-term capital gains and qualified dividends have favorable tax treatment that is lower than ordinary income tax rates
• State Income Tax on
  • Short-term capital gains and ordinary dividends
  • Long-term capital gains and qualified dividends

Tax on Dividends

• qualified dividends
  • A qualified dividend is taxed at the capital gains tax rate 3
  • The tax rate for qualified dividends ranges from 0% to 20% 2 3
• ordinary dividends
  • aka non-qualified / unqualified dividends
  • ordinary dividends are taxed at standard federal income tax rates 3
  • The maximum tax rate for ordinary dividends for the 2021 and 2022 calendar years, is 37% 2 3

Tax on capital gains

For capital gains, there are two rates:

• Long-term (for assets held longer than one year)
  • Long-term capital gains are smaller with a maximum of 20%
• Short-term (less than one year)
  • Short-term gains are taxed as ordinary income, taxable at federal income tax rates

Additional rules if applicable

• Individuals with substantial income from investing may also pay an additional 3.8% Net Investment Income Tax (NIIT)
• You are subject to the wash-sale rules if you sell a stock for a loss and then buy it back within 30 days

Example

Situation:

• young couple, California residents, married filing jointly, annual wages under USD 170k
• have a USD 20k-investment taxable account, with
  • short-term gain/loss: 0
  • long-term gain/loss: 0
  • ordinary dividends: USD 460
  • qualified dividends: USD 312
• how much is the tax bill on investment account on 2021?

Applied into this situation, we will have:

• federal income tax rates: 24%
• California state income tax rate: 9.3%
  • California taxes all income from all sources inside and outside California
  • It does not have a lower rate for qualified dividends. All dividends are taxed as ordinary income
• qualified dividends are taxed at 15%
• ordinary dividends are taxed at 24%

So the tax bill on investment account will be:

• California state income tax:
  • $9.3\%*(460+312)=\$\ 72$
• Federal state income tax:
  • $24\%*460+15\%*312=110.4+46.8=\$\ 157.2$

1. Income Tax in US
2. Ordinary Dividend
3. Qualified Dividend

Footnotes

1. Internal Revenue Service. Publication 550: Investment Income and Expenses, Page 2. Accessed Sept. 24, 2020.˄

2. Internal Revenue Service. Publication 550: Investment Income and Expenses (Including Capital Gains and Losses), Page 19. Accessed Jan. 22, 2022.˄

3. Internal Revenue Service. IRS Provides Tax Inflation Adjustments for Tax Year 2022. Accessed Jan. 22, 2022.˄

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