Investing and Taxes: Some Important Basics to Know

August 2, 2024

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What we’ll cover:

Investment income is typically subject to federal tax.
How much tax you’ll potentially pay depends on the type of investment income you receive.
Interest income, dividends, and capital gains are generally subject to different tax rates and rules.

If you invest, it’s important to know that each type of investment income you earn comes with its own set of tax rates and rules (see IRS Publication 550).

Keep in mind that while we can help go over the basics of how and when investment income is taxed by the IRS, it’s a good idea to consult a tax advisor about your personal tax situation and what rules may apply to your specific investments.

Different types of investment income are taxed differently

How investments are taxed depends on several factors, including the type of account, the type of income you earned, and when the assets were sold. Here are some common types of federal taxes on investments and how they may be applied.

Tax on dividends

If you own stocks, you’re probably already familiar with dividends, which are payments from the earnings and profits of a company or corporation in which you’re a shareholder. Per the IRS, dividend payments are taxable.

How the tax works: Not all dividends are taxed the same way. The tax rate varies depending on your tax bracket and whether the dividends are considered “ordinary” or “qualified.”

Ordinary dividends (also referred to as nonqualified dividends) are treated as ordinary income, meaning they’re taxed at your usual income tax rate.
Qualified dividends, on the other hand, are taxed at special rates if they meet certain IRS requirements. Depending on your taxable income and filing status, qualified dividends may be taxed at a 0%, 15% or 20% rate.

Generally speaking, dividends from the stocks of US corporations are considered qualified, so long as you’ve held the stocks for more than 60 days. For more details, see IRS Publication 550, "Qualified Dividends."

Tax on interest income

You typically have to pay taxes on the interest you earn from bank deposit accounts (think: savings accounts, certificates of deposit) as well as debt securities like corporate bonds.

It’s a good idea to consult a tax advisor about your personal tax situation and what rules may apply to your specific investments

How the tax works: Most interest income is treated like ordinary income. In other words, it’s taxed at your ordinary income rate. However, interest payments from certain types of bonds, such as some municipal bonds, may be tax-exempt. Generally, many bonds issued by state and local governments are exempt from federal income tax (but they may still be subject to state and local taxes in certain cases).

Tax on capital gains

When you invest, you may also earn what is known as capital gains, which are the profits that you make when you sell an asset such as a stock, bond, or exchange-traded fund (ETF). Capital gains are considered “realized” when you actually sell your investment, and the money that you make from the sale is generally taxable.

How the tax works: The tax you pay on your capital gains depends on how long you’ve held onto your investments (short term vs. long term).

Long-term capital gains – gains on investments held for more than a year – are subject to a 0%, 15%, or 20% tax rate based on your level of taxable income. (Note: There are a few exceptions where capital gains may be taxed at rates greater than 20% – see IRS Topic 409).
Short-term capital gains – gains on investments held for one year or less – are taxed at your ordinary income rate.

Because you could sell multiple assets in a given year, it can get a little tricky trying to calculate your potential capital gains tax. You typically need to figure out details like: how long you held onto the assets; cost basis (translation: how much you originally paid for the assets); and net capital gain (or loss). These calculations can be complex depending on your situation, so it’s a good idea to consult a professional tax advisor who can help you accurately crunch the numbers.

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Good to know: Sometimes, in a tough investment year, you might experience a “capital loss,” where you lose money from your investment sales. Generally, you can deduct up to $3,000 net capital losses a year on your tax return ($1,500 if married filing separately).

If you’re planning on deducting tax losses, it's a good idea to check in with a tax professional to ensure you’re not violating IRS wash-sale rules (see IRS Publication 550). A wash sale is when you sell or trade an investment at a loss and purchase a substantially identical investment within 30 days before or after the sale. According to IRS rules, you cannot deduct losses related to wash sales.

Tax on investment funds

When you invest through a fund like a mutual fund or ETF, the fund typically distributes any dividends, interest, or capital gains earned from the securities held within the fund’s portfolio at the end of each year.

How it works: The tax you potentially owe on those distributions depends on the securities that the fund holds and how long they’ve been held. The type of distribution you receive is also a factor. For instance, if you’re invested in a bond fund, you may receive interest distributions that are considered taxable interest income. Or if you’re invested in a stock fund, you may have to pay taxes on your dividends.

Keep in mind, too, that distributions may be taxable even if you don’t take the money out of your account (for example, if you simply reinvest them to buy more shares).

Good to know: If you sell shares of the mutual fund or ETF itself and make a profit, you may also owe taxes from the sale of those shares (realized capital gains).

A quick word on the Net Investment Income Tax

So far we’ve talked about taxes on investment earnings from individual types of securities like bonds, stocks, and mutual funds. But there’s another type of investment tax that you should be aware of – the Net Investment Income Tax (NIIT).

This tax is a little different from the ones we’ve covered so far. That’s because the NIIT isn’t imposed on any one specific type of investment earnings or profit. Rather, it’s a 3.8% tax applied to the net investment income of individuals whose income exceeds certain dollar amounts (ranging from $125,000 to $250,000, depending on your filing status). Note that the NIIT may also be applied to certain net investment income of estates and trusts that have income above the statutory threshold amounts. If you have questions about whether the NIIT applies to you, consult a tax advisor.

Now, what does the IRS consider as investment income? Generally, net investment income includes interest payments, dividends, capital gains, rental and royalty income, as well as non-qualified annuities.

For more infromation on the NIIT, visit the the IRS webpage.

Financial firms send tax information to customers each year

If you have any investment account, your financial firm should send you information about your holdings each year, which you can use to help file your income tax return.

You may either get these tax documents in the mail or online. These tax documents are essentially a summary report on the various types of income generated by your investments. You may also receive a form listing capital gains or losses from any securities sales.

Firms may use some of the following forms to report your investment income to you (and to the IRS):

Form 1099-INT for interest income
Form 1099-DIV for dividends and other distributions (including capital-gains distribution)
Form 1099-B for proceeds from investment sales and other transactions

Gathering all the necessary documents and forms to file your federal income tax return can be a real chore (whether you’re doing it yourself or with the help of a professional). And trying to figure out your investment tax obligations can add another layer of stress. But remember – this isn’t something you have to do on your own. Definitely consider working with a professional financial or tax advisor who could help ensure that you’re reporting your investment income accurately and that you understand what kind of investment taxes you may potentially owe at the end of the tax year.

This article is for informational purposes only and is not a substitute for individualized professional tax advice. Individuals should consult their own tax advisor for matters specific to their own taxes. This article was prepared by and approved by Marcus by Goldman Sachs, but does not reflect the institutional opinions of The Goldman Sachs Group, Inc., Goldman Sachs Bank USA, Goldman Sachs & Co. LLC or any of their affiliates, subsidiaries or divisions. Goldman Sachs Bank USA and Goldman Sachs & Co. LLC are not providing any financial, economic, legal, accounting, tax or other recommendations in this article. Information and opinions expressed in this article are as of the date of this material only and subject to change without notice. Information contained in this article does not constitute the provision of investment advice by Goldman Sachs Bank USA, Goldman Sachs & Co. LLC or any of their affiliates. Neither Goldman Sachs Bank USA, Goldman Sachs & Co. LLC nor any of their affiliates makes any representations or warranties, express or implied, as to the accuracy or completeness of the statements of any information contained in this document and any liability therefore is expressly disclaimed.