February 7, 2018 – Many investors, especially more risk-averse ones, hold much of their portfolios in “income investments” — those that pay interest or dividends, with less emphasis on growth in value. But all income investments aren’t alike when it comes to taxes. So it’s important to be aware of the different tax treatments when managing your income investments.
Varying tax treatment
The tax treatment of investment income varies partly based on whether the income is in the form of dividends or interest. Qualified dividends are taxed at your favorable long-term capital gains tax rate (currently 0%, 15% or 20%, depending on your tax bracket) rather than at your ordinary-income tax rate (which might be as high as 37%). Interest income generally is taxed at ordinary-income rates. So stocks that pay dividends might be more attractive tax-wise than interest-paying income investments, such as CDs and bonds.
But there are exceptions. For example, some dividends aren’t qualified and therefore are subject to ordinary-income rates, such as certain dividends from: Real estate investment trusts (REITs), Regulated investment companies (RICs), Money market mutual funds, and Certain foreign investments. Also, the tax treatment of bond interest varies. For example: Interest on U.S. government bonds is taxable on federal returns but exempt on state and local returns. Interest on state and local government bonds is excludable on federal returns. If the bonds were issued in your home state, interest also might be excludable on your state return. Corporate bond interest is fully taxable for federal and state purposes.
One of many factors
While tax treatment shouldn’t drive investment decisions, it’s one more factor you shouldn’t forget to consider when it comes to income investments.
For help factoring taxes into your investment strategy, contact us.
For more information, please contact Victoria S. Carlin at firstname.lastname@example.org.
About the Author
Victoria S. Carlin CPA
Victoria has over 27 years of experience in providing tax consulting, compliance and tax audit representation to closely held businesses, delivering a full range of tax services in federal, multi‐state, and cross-border tax laws and regulations for partnerships, S and C corporations, and individuals.