Never forget these two axioms:
Money frees us, but its pursuit enslaves us.
It’s not how much you have at the end; it’s how much you could have made.
Last time, we reviewed the basics of the federal income tax system and its latest changes. This post will detail the basics of how investments are taxed.
As noted previously, the recent tax reform bill that was passed in late 2017 changed federal income taxes significantly. One thing that didn’t change however is the following: Dividends are considered “qualified” once you own the stock or fund producing the dividend for over sixty days (ninety days for preferred stock). Selling before that would make your dividends taxed as ordinary income which would mean that they are taxed far higher than what the taxes would be for qualified dividends given the income levels for the average physician.
Dividends are now taxed at the following rates:
- 0% below $77,200 of taxable income for married joint filers or below $38,600 if single (or, the rarer category, married filing separately)
- 15% between $77,200-$479,000 for married joint filers or $425,800 if single (or, in the rarer category of being married, but filing separately, $38,600-$239,500)
- 20% if above any of the upper thresholds listed above in the 15% bracket
- The 3.8% NIIT (Net Investment Income Tax also called the Obamacare surtax among many other things) is still applied to all dividends based on your modified adjusted gross income of $250,000 for married joint filers or $200,000 for single (or all other) filers.
As of 2013, the dividend tax had been 15% (or 20% for you all rich fat cats that light your fancy cigars with $100 bills and were in the top income tax bracket of 39.6%) with a 3.8% surcharge for married couples with incomes over $250,000 or single taxpayers with an income of $200,000 which was enacted in 2010 to help pay for the Affordable Care Act. [Thanks a lot, Obama!])
If you were in the top income tax bracket of 39.6% from 2010-2017, your entire dividend tax was 23.8% (20% dividend tax + 3.8% NIIT) except for the sad residents of the great states of Tennessee and New Hampshire whose states tax dividends (but not income).
Thankfully, for the sake of convenience (if nothing else), capital gains (selling a security like a stock or mutual fund for more than you bought it for) is taxed at the exact same levels as dividends are (see above) except for one major subtraction.
There is no NIIT levied against your capital gains.
So, if you’re selling stocks and/or funds for a gain, your profits alone (not the original amount invested) will be taxed at a capital gains tax rate. Short term capital gains are defined as anything held less than a year. Anything held over a year and then sold for a profit is considered a long-term capital gain. Short term capital gains are taxed at whatever level your income level determines as short-term capital gains are taxed as what is known as “ordinary income”.
Long term capital gains, however, are taxed far below what the taxes would be for short-term capital gains given the income levels for the average physician. Therefore, hold on to those stocks/funds as best as you can for at least 366 days. It’ll be worth your while. (This definitely should change your thinking on day trading as all those profits are being taxed at a much higher rate [most probably] than if it had been held. As will be discussed in a later post, you should only consider your gains after all the taxes and fees have been paid out. Therefore, you should ALWAYS [rare in medicine, even rarer in life that we can use this word, so ALWAYS [see what I did there?] pay attention when you it is used] pick the most tax efficient investing route possible.)
Just to be clear…
Please understand that only the profits are taxed at the above rates, not the entire amount of proceeds. (For example, if you put $30,000 into a fund [ Whoa there big spender!] and then sell it at $50,000 five years later, then you will be taxed on the $20,000 profit, not all $50,000.)
Realize that there are no local or state taxes on dividends. There are no local taxes on capital gains, but there are state taxes on any capital gain.
There’s entire professions, seminars, books, and the like designed for all of this, so we will revisit this from time to time, but never be even close to being comprehensive. The more complex your taxes are/become, the more you’ll need an outstanding tax professional.
I’d love to hear from any and all of you about your thoughts, so we can all learn from one another.
Please spread the word about this blog to your friends (real and virtual), family, and colleagues.
Talk to you soon.
Until next time…