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We make it easy to do everyday banking at Horizon, but everybody still needs some sensible advice from time to time to help with their goals and strategies for saving, investing wisely and making the most out of your financial journey. That’s why we provide fresh advice topics to help you along the way.

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Make Investing Easy: Understand The Basics Of Investment Taxes

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Is It Ordinary Income or Capital Gain?

To determine how an investment is taxed in a given year, consider what went on with the investment. Did it generate interest income? Then it’s probably considered ordinary income. Did you sell the investment? If so, you might have a capital gain or loss. If you receive dividend income, it may be taxed either at ordinary income tax rates or at the rates that apply to long-term capital gain income. The distinction is important because different tax rates may apply, and different reporting procedures may be involved. Here are some of the things you need to know.

Categorizing Your Ordinary Income

Examples of ordinary income include interest and rent. Many investments can generate ordinary income, including savings accounts, certificates of deposit, money market accounts, annuities, bonds, and some preferred stock. Ordinary income is taxed at ordinary tax rates and can be categorized as:

     Taxable income. This income isn’t tax-exempt or tax-deferred.

     Tax-exempt income. Municipal bonds and U.S. securities are typical examples.

     Tax-deferred income. This taxation is postponed and includes 401(k) retirement plans.

Understanding Basis

Basis refers to the amount of your investment in an asset. Your initial basis equals what you paid for the asset, but it can differ from the cost if you received the asset as a gift or inheritance. Adjusted basis occurs when your initial basis increases or decreases over time. You can learn more about which items increase or decrease the basis of your asset in the IRS Publication 551.

Calculating Your Capital Gain or Loss

If you sell stocks, bonds, or other capital assets for more than you purchased them, you'll have a capital gain. Special capital gains tax rates may apply. These rates may be lower than ordinary income tax rates. Alternately, if you sell assets for less than you purchased them, you’ll have a loss. Schedule D of your income tax return is where you’ll calculate your short-term and long-term capital gains and losses.

Using Capital Losses to Reduce Your Tax Liability

You can use capital losses from one investment to reduce the capital gains from other investments. You can also use a capital loss against up to $3,000 of ordinary income this year. Losses not used this year can offset future capital gains. Schedule D of your federal income tax return can lead you through this process.

New Medicare Contribution Tax on Unearned Income May Apply

High-income individuals may be subject to a 3.8% Medicare contribution tax on unearned income. Interest on tax-exempt bonds is not considered net investment income for purposes of the additional tax. Qualified retirement plans and IRA distributions are also not considered investment income.

Getting Help When Things Are Complicated

The sales of some assets are more difficult to calculate and report than others, so you may need to consult an IRS publication or other tax references to correctly calculate your capital gain or loss. Also, remember that you can always seek the assistance of your Horizon Bank Trust advisor at (219) 873-2683.

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