Many young people are starting to dabble with investing through virtual platforms such as mobile apps and websites. While it can be fun to jump in and hopefully make some cash, it’s important to factor in the tax implications once you open that door. Investing can earn you money in a couple key ways; so, you’ll want to know how this affects your income reporting at tax time.
Dividends are paid by some companies at regular intervals to their shareholders. They can be paid monthly, quarterly, semiannually, or annually, depending on the company or investment type. Investors have the option to reinvest these dividends automatically into additional investments or to receive them as cash. If you’re receiving dividends, this is considered reportable income, no matter what you choose to do with them. If you receive more than ten dollars in a year, you will receive Form 1099-DIV to file with your taxes. Most dividends will be taxed as normal income, meaning they’ll be taxed at the same rate as income from your job.
When you earn money because of an increase in value of an investment, this is called a capital gain. For example, if you buy a share of stock at $10.00 and sell it for $20.00, you earned a capital gain of $10.00 as profit. For capital gains, the tax rates are somewhat different from dividends. How they are taxed also depends on how long you owned the investment.
Short-term: If you owned an investment for a year or less, any money earned will count as short-term capital gains and will be taxed at the same rate as your normal income.
Long-term: If you owned an investment for more than a year, any capital gains will be taxed at the long-term capital gains rate. Long-term gains are taxed at a lower rate than standard income, so there is an incentive to own your investments for a longer period of time before cashing in on any profits.
The main reason people invest is to make money, but this doesn’t always pan out. Sometimes, people lose money on their investments, which affects their taxes as well. When you sell an investment for less than you paid for it, this is considered a capital loss. These losses are first measured against any capital gains of the same type.
For example, if you earned $10.00 in short-term capital gains, but had $5.00 in capital losses, you can subtract the losses. In this situation, tax would only apply to the remaining $5.00 in capital gains. Totals for losses and gains must still be reported on your taxes.
Long-term losses are measured against long-term gains in the same way. If you lost more money than you gained, you can actually deduct these losses from your income up to a set limit for each tax year. You may also carry over any additional losses to file with the following couple years’ taxes.
The bottom line
As soon as you purchase an investment, there are potential tax implications. It’s important to be aware of how this could impact your financial picture and that you’re keeping track of any earnings and losses. It’s also worth noting that investment activity in retirement accounts like a 401k or Individual Retirement Account (IRA) are not subject to taxes until you withdraw money during retirement. Tax forms issued by investment brokers can sometimes be confusing, so if you have any concerns, you’ll want to consult a tax advisor for clarification.