Taxes and Investing: What First-Time Investors Need to Know About Filing Taxes

If you made any investments last year, there are some things you should think about when you file your taxes.

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Investing is an excellent way to grow wealth, but it can also have implications for your taxes. As a first-time investor, it’s important to understand how taxes and investing work together: how your earnings will impact your tax situation, and how to report all income properly. We’ve broken down common tax situations investors may encounter and how to deal with them.

What Investors Should Keep in Mind When Filing Taxes

1. Capital Gains Tax

A capital gain is a profit you earn when you sell an asset — often real estate or stock — for more than you bought it. Capital gains are taxed, but the rate you’ll pay depends on what type of gain it was, which is determined by how long it was held.

  • A short-term capital gain comes from the sale of an asset you owned for one year or less. These gains are simply taxed at the same rate as your regular income.
  • A long-term capital gain happens when you sell an asset that you hold for more than one year before you sell. These gains are taxed a bit differently. Depending on your income, you’ll pay a capital gains tax rate of either 0%, 15%, or 20%.

Here’s what the income brackets for long-term capital gains look like for the 2020 tax year:

Tax Filing Status 0% 15% 20%
Single Up to $40,000 $40,001 to $441,450 More than $441,450
Married Filing Jointly Up to $80,000 $80,001 to $496,600 More than $496,600
Married Filing Separately Up to $40,000 $40,001 to $248,300 More than $248,300
Head of Household Up to $53,600 $53,601 to $469,050 More than $469,050

Keep in mind that a capital gain on a single asset might not result in a tax liability. Capital gains can be offset by capital losses. Captial losses occur when you sell an asset for less than you bought it. You’re taxed on your net gain after accounting for any capital losses you had. If your capital losses exceed your capital gains, you can reduce your taxable income. Capital losses that exceed capital gains can also offset your ordinary income like wages up to $3,000, lowering your taxable income. Capital losses greater than $3,000 can carry forward and be used to offset income in future tax years.

You claim your capital gains or losses on IRS Form 8949 and then summarize them on Schedule D of IRS Form 1040. To make sure you are filing correctly, consider using a tax preparation service like TurboTax. With TurboTax, you are not required to know tax rules or forms. If you are an investor TurboTax can automatically import and upload 1,550 stock transactions and 2,250 crypto transactions at once avoiding manual entry and helping you accurately figure out your gains and losses. And with TurboTax, you can get special guidance from a tax expert on your investments.

Find out more in our TurboTax review.

2. Net Investment Income Tax

The net investment income tax is a tax that certain investors must pay if their modified adjusted gross income (MAGI) exceeds a certain amount.

Your MAGI is based on your adjusted gross income, plus any untaxed foreign income, non-taxable Social Security benefits, and tax-exempt interest.

You’ll be subject to the net investment income tax if your MAGI exceeds the following:

Filing Status MAGI Threshold
Single $200,000
Married Filing Jointly $250,000
Married Filing Separately $125,000

The net investment income tax rate is 3.8% and applies to investment income that includes, but isn’t limited it:

  • Capital gains
  • Dividends
  • Interest
  • Rental and royalty income
  • Passive income
This tax doesn’t apply to any non-investment income. Your wages, active business income, government benefits, and other tax-exempt investment income aren’t subject to the next investment income tax.

If you’re subject to the net investment income tax, you can use IRS form 8960 to calculate your tax liability and report it on IRS Form 1040. Read more about tax-efficient investing here.

3. Interest Income

If you received interest income throughout the year, you must pay taxes on those earnings. Many people receive this type of income throughout the year, often without even realizing it. Interest income can come from sources that include, but aren’t limited to:

You should receive a Form 1099-INT for any interest that exceeds $10 for a particular tax year, but you must report all interest income, even if you didn’t receive this form.

Interest income is taxed at your normal income tax rate. This income is reported on your Form 1040. If your interest income exceeds $1,500, you may also need to report it on a Schedule B form.

4. Dividends

A dividend is a distribution that a corporation pays to its shareholders as a way of sharing its profits. Investors may earn dividends by investing in individual stocks or funds. Companies most often pay dividends in cash, but might also compensate employees with stock or other assets.

Dividends fall into two categories: Ordinary and Qualified. The key difference between the two is how they’re taxed. Ordinary dividends are taxed as normal income, while qualified dividends are taxed as capital gains.

If you receive either ordinary or qualified dividends, you’ll receive a Form 1099-DIV for any distributions of at least $10. You report both of these dividends directly on your Form 1040. You may also have to file a Schedule B form if your ordinary dividends exceed $1,500.

Are IRAs Taxed?

If you contribute to or withdraw from an individual retirement account (IRA) it’s important to understand the tax implications. First, it’s important to understand the difference between the two types of IRAs:

  1. Traditional IRA: Contributions are tax-deductible, earnings are tax-deferred, and withdrawals are taxed as regular income.
  2. Roth IRA: Contributions are made after-tax, and earnings and withdrawals are tax-free.

Because contributions are made after-tax, contributions to a Roth IRA have no impact on your tax situation at the time you make them. But contributions to a traditional IRA are tax-deductible, meaning they can help to reduce your taxable income for the year.

Withdrawals are just the opposite. Because you’ve already paid income taxes on the money you contributed to your Roth IRA, you won’t pay taxes when you withdraw the money during retirement. But because your traditional IRA contributions were tax-deductible, you’ll pay income taxes on your withdrawals.

In most cases, you won’t have to worry about paying taxes on your IRA until you withdraw money from a traditional IRA during retirement, but there are some exceptions.

First, if you withdraw money before you reach age 59½, you’ll pay the regular taxes on those withdrawals, as well as an additional 10% penalty.

Note:  Under the CARES Act, if you took an early distribution from your retirement because you were impacted by Coronavirus the 10% penalty may be waived and the distribution can be included in your income over three years instead of one year.

You can also do what is called a Roth conversion, where you convert the money in your traditional IRA into a Roth IRA. You pay income taxes on the money you convert but then can withdraw the money tax-free during retirement.

Because Roth IRAs are only available to individuals under a certain income level, the Roth conversion is a way for high earners to take advantage of this type of account.

If you have taxable IRA distributions, you report those on your IRS Form 1040.

Bottom Line: There are Many Resources Here to Help

When you’re new to investing, it can feel overwhelming trying to navigate the tax code of investing. While these earnings may complicate your tax return a bit, the benefits far outweigh the inconvenience. And the good news is that there are plenty of resources out there to help you file your taxes. If you don’t feel comfortable properly reporting your investment income on your own, seek the help of a tax professional like TurboTax, where you can import and upload 1,550 stock transactions at once and connect with a tax expert who can help you along the way.

Erin Gobler

Erin Gobler is a freelance personal finance based in Madison, Wisconsin. After seven years working in state politics, she left to pursue writing full-time. Now she writes about financial topics including mortgages, investing, and more for major publications like Fox Business and NextAdvisor. In addition to finance writing, Erin also provides financial coaching services where she works with individuals to help them reach their money goals.

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