Non-retirement accounts, also known as taxable investment accounts, are subject to various taxes. Understanding how these accounts are taxed is important for anyone who wants to invest their money outside of a retirement account. In this article, we will explore the different types of taxes that apply to non-retirement accounts and how they are calculated.
One of the most common types of taxes that apply to non-retirement accounts is capital gains tax. This tax is applied when you sell an investment for a profit. The amount of tax you owe depends on how long you hold the investment and your income level.
Short-term capital gains are taxed at a higher rate than long-term capital gains, and those in higher income tax brackets will pay a higher percentage of their gains in taxes.
Another tax that applies to non-retirement accounts is the dividend tax. This tax is applied to the income you receive from stocks or mutual funds. The amount of tax you owe on dividends depends on your income level and the type of dividend you receive.
Some dividends are taxed at a lower rate than others, so it’s important to understand the difference. By understanding the various taxes that apply to non-retirement accounts, you can make informed decisions about your investments and minimize your tax liability.
Taxation of Non-Retirement Accounts
When it comes to non-retirement accounts, there are three main types of taxes to consider: capital gains tax, dividend tax, and interest income tax.
Capital Gains Tax
Capital gains tax is a tax on the profit you make when you sell an asset, such as stocks or real estate. The tax rate for capital gains depends on how long you hold the asset. If you hold the asset for more than a year, it is considered a long-term capital gain and is taxed at a lower rate than short-term capital gains.
Dividend Tax
Dividend tax is a tax on the income you receive from dividends paid by stocks or mutual funds. The tax rate for dividends also depends on how long you hold the asset. Qualified dividends, which are paid by U.S. corporations or qualified foreign corporations, are taxed at the same rates as long-term capital gains. Non-qualified dividends, which are paid by real estate investment trusts (REITs) or master limited partnerships (MLPs), are taxed as ordinary income.
Interest Income Tax
Interest income tax is a tax on the interest you earn from savings accounts, CDs, bonds, and other fixed-income investments. The tax rate for interest income is the same as your ordinary income tax rate. However, if you invest in municipal bonds issued by your state or municipality, the interest income is usually exempt from federal income tax and sometimes state income tax.
In summary, non-retirement accounts are taxed differently depending on the type of income you receive. Capital gains are taxed at different rates depending on how long you hold the asset, while dividends and interest income are taxed as ordinary income or at lower rates for qualified dividends and municipal bond interest.
When Are Non-Retirement Accounts Taxed?
There are two circumstances in which non-retirement accounts are taxed: realized and unrealized gains and losses.
Realized Gains and Losses
When you sell an asset from your non-retirement account, such as stocks, bonds, or mutual funds, you will realize either a gain or a loss.
A realized gain occurs when you sell an asset for more than you paid for it, while a realized loss occurs when you sell an asset for less than you paid for it.
Realized gains are typically taxed at the capital gains tax rate, which varies depending on your income and how long you hold the asset. Short-term gains, which occur when you hold the asset for one year or less, are taxed at your ordinary income tax rate. Long-term gains, which occur when you hold the asset for more than one year, are taxed at a lower rate.
Realized losses can be used to offset realized gains, reducing your overall tax liability. If your losses exceed your gains, you can deduct up to $3,000 of the excess each year from your ordinary income.
Unrealized Gains and Losses
Unrealized gains and losses occur when the value of an asset in your non-retirement account changes, but you have not sold it. For example, if you own a stock that increases in value, you have an unrealized gain. If the stock decreases in value, you have an unrealized loss.
Unrealized gains and losses are not taxed until they are realized, meaning you sell the asset. However, if you hold an asset for a long time and it appreciates significantly, you may face a large tax bill when you eventually sell it.
It is important to keep track of your unrealized gains and losses, as they can have a significant impact on your overall tax liability. You may want to consider selling assets with unrealized losses to offset realized gains and reduce your tax bill.
In summary, non-retirement accounts are taxed based on realized gains and losses, which occur when you sell an asset, and unrealized gains and losses, which occur when the value of an asset changes but you have not sold it. Keep track of your gains and losses to minimize your tax liability.
Taxation of Different Types of Non-Retirement Accounts
Other types of non-retirement accounts include individual brokerage accounts, joint brokerage accounts, and trust accounts.
Individual Brokerage Accounts
When it comes to individual brokerage accounts, any gains you make from selling investments are taxed as capital gains. If you hold onto your investments for less than a year, they are considered short-term capital gains and taxed at your ordinary income tax rate.
If you hold onto them for longer than a year, they are considered long-term capital gains and taxed at a lower rate.
In addition to capital gains, you may also receive dividends from your investments. These dividends are taxed at either your ordinary income tax rate or at a lower rate, depending on the type of dividend.
Joint Brokerage Accounts
Joint brokerage accounts are similar to individual brokerage accounts, but the tax implications can be a bit more complicated. The gains and dividends are split between the account owners, and each owner is responsible for paying taxes on their portion.
If one owner passes away, the other owner will receive a step-up on the basis of their portion of the account. This means that the cost basis of the investments will be adjusted to the current market value, which can result in lower capital gains taxes if the investments are sold.
Trust Accounts
Trust accounts are a bit different from individual and joint brokerage accounts. The trust itself is considered a separate entity for tax purposes, and any income earned by the trust is taxed at the trust tax rate.
If the trust distributes income to the beneficiaries, the beneficiaries will then pay taxes on that income at their ordinary income tax rate. The tax implications of trust accounts can be complex, so it’s important to consult with a tax professional if you have questions.
Tax-Efficient Strategies for Non-Retirement Accounts
When it comes to non-retirement accounts, taxes can have a significant impact on your investment returns. However, there are several tax-efficient strategies you can use to minimize your tax liability and maximize your after-tax returns.
Tax-Loss Harvesting
Tax-loss harvesting is a strategy that involves selling investments that have decreased in value to offset gains from other investments. By doing this, you can reduce your tax liability and potentially increase your after-tax returns.
For example, let’s say you have a non-retirement account with $100,000 in stocks. One of the stocks has decreased in value by $10,000, while another has increased in value by $10,000. By selling the stock that has decreased in value, you can offset the gains from the other stock and reduce your tax liability.
Asset Location
Asset location is another tax-efficient strategy that involves placing investments in the right type of account to minimize taxes. For example, investments that generate a lot of income, such as bonds, are better suited for tax-advantaged accounts like IRAs, while investments that generate long-term capital gains, such as stocks, are better suited for non-retirement accounts.
By using asset location, you can reduce your tax liability and potentially increase your after-tax returns.
Tax-Managed Funds
Tax-managed funds are mutual funds or exchange-traded funds (ETFs) that are designed to minimize taxes. These funds use strategies like tax-loss harvesting and asset location to minimize taxes and maximize after-tax returns.
By investing in tax-managed funds, you can reduce your tax liability and potentially increase your after-tax returns.
In summary, tax-efficient strategies like tax-loss harvesting, asset location, and tax-managed funds can help you minimize your tax liability and maximize your after-tax returns in non-retirement accounts. By using these strategies, you can make the most of your investments and achieve your financial goals.
Conclusion
In summary, non-retirement accounts are taxed differently depending on the type of income earned and the holding period. Short-term capital gains and interest income are taxed at ordinary income tax rates, while long-term capital gains and qualified dividends are subject to lower tax rates. Additionally, non-retirement accounts may incur taxes on dividends and capital gains distributions, as well as on the sale of assets.
To minimize taxes on non-retirement accounts, you can consider strategies such as tax-loss harvesting, holding assets for longer periods to qualify for lower tax rates, and investing in tax-efficient funds. It is also important to keep track of your cost basis and to consult with a tax professional to ensure compliance with tax laws and regulations.
Overall, non-retirement accounts can be a valuable tool for achieving your financial goals, but it is important to understand the tax implications and to plan accordingly. By staying informed and making informed decisions, you can maximize the benefits of your non-retirement accounts and minimize the tax impact.
Frequently Asked Questions
Here are some common questions about this topic:
How are non-retirement accounts taxed?
Non-retirement accounts, such as brokerage accounts, are subject to capital gains tax. This tax is applied when you sell an asset, such as stocks, for a profit. The amount of tax you pay depends on how long you hold the asset before selling it.
If you held the asset for less than a year, you would be subject to short-term capital gains tax, which is taxed at your ordinary income tax rate. If you held the asset for more than a year, you would be subject to long-term capital gains tax, which is taxed at a lower rate.
What is the difference between realized and unrealized gains?
Realized gains are gains that you have actually received from selling an asset. Unrealized gains, on the other hand, are gains that you have not yet received because you have not sold the asset. You are not taxed on unrealized gains until you sell the asset and realize the gain.
Can I offset capital gains with capital losses?
Yes, you can offset capital gains with capital losses. If you have more capital losses than capital gains, you can use the excess losses to offset up to $3,000 of ordinary income each year. If you have more than $3,000 in excess losses, you can carry them forward to future years.
Are there any tax advantages to holding assets in a non-retirement account?
Yes, there are some tax advantages to holding assets in a non-retirement account. For example, if you hold an asset for more than a year, you will be subject to long-term capital gains tax, which is taxed at a lower rate than short-term capital gains tax.
Additionally, if you donate appreciated assets to charity, you can receive a tax deduction for the fair market value of the asset, and you will not have to pay capital gains tax on the appreciation.