Do Investments Count As Income? 4 Common Investment Methods

Editorial team of TFX

• 28.03.22 • 5 min read

If you're looking to grow your portfolio, investing can be a great way to do so. There are different types of investments available. However, do you know what to do when it comes time to file your taxes? In fact, the answer to your tax question depends on the specific situation you are facing.

Taxes are typically affected by your investments twice a year.

1. Firstly, the income generated by your investment vehicle.

2. The second scenario is when you sell the investments and realize a profit or loss.

It is important to realize that there are potential exceptions to this rule, and TFX can help you figure out if any of these situations match what you are experiencing when you are preparing your tax return. Despite the differences in circumstances and experiences, there are a few questions that remain the same regardless; Do investments count as income? Do I have to pay taxes on investment earnings? Do you have to file taxes for investments? Do you have to report investments on taxes? Does investment count as income?

Here are four common types of taxes on investment vehicles and what you can do to minimize what you owe.

Tax On Dividends

Generally, dividend income is taxable in the year it is received. Dividends you receive in cash are still taxable to you, even if you automatically reinvested them to buy additional shares of the underlying stock, such as through a dividend reinvestment plan (DRIP). You can receive special tax treatment depending on the dividend income you receive.

Dividends can be categorized into two types: non-qualified and qualified dividends. Your tax rate will be the same as your regular income tax bracket if you receive a nonqualified dividend. If you have taxable income and filing statuses that qualify for dividend taxation, the tax rate is low: 0%, 15% or 20%. Your broker or any entity that sent you at least $10 in dividends and other distributions will send you a Form 1099-DIV or a Schedule K-1 at the end of the year. A 1099-DIV reveals what you received as well as the class of dividends you received.

Tax On Capital Gains

An asset - shares of stock, a plot of land, a business - is considered to be a capital gain when it is sold for profits. Capital gains can probably be treated as taxable income.

You can earn capital gains on these items if you sell them. You may be required to pay capital gains tax on returns that you make from selling a stock for a profit of $30,000 this year. If you hold the asset for a long time before you sell it, the rate you will pay is influenced by that factor. In general, capital gains tax is 0%, 15% or 20% on most assets held longer than a year. As per the IRS, the capital gains tax on most assets held less than a year corresponds to the ordinary income tax rate.

If you have any capital losses, they can be offset against your capital gains. Capital losses, as well as capital gains, are both characterized by long-term and short-term forms. Here is how you offset your capital gains including the short-term capital gains with your capital losses.

The tax on capital gains of $15,000 is triggered if, for instance, you sold stock this year for a profit of $30,000 and sold another for a loss of $17,000. 

Tax On Mutual Funds

Unlike regular taxes, taxing your mutual fund investments includes taxes on dividends and capital gains as long as you own the funds, as well as capital gains taxes when you sell the funds.

From the investments within your mutual fund, dividends, interest, and capital gains may be generated. Therefore, even if you haven't sold your investments or received any cash, you could be liable for taxes on them. Distributions you get from mutual funds and other factors determine your tax rate. You might have to pay capital gains tax if you sell your mutual fund shares.

You may qualify for lower capital gains tax rates if you hold onto your shares for at least one year. Taxes on the interest, dividends or gains your mutual fund distributes could be deferred by holding mutual fund shares in retirement accounts. There are also options to harvest tax losses and choose funds that distribute taxable income less frequently.

Taxes On Investments In A 401(K)

As a general rule, you do not have to pay taxes on the money you put into a traditional 401(k). Furthermore, during the time the money is in the 401(k), you are not taxed on investment gains, interest or dividends. Taxes are only levied when funds are withdrawn. The Roth IRA 401(k) requires upfront taxes, but when you retire, your qualified distributions won't be taxable.

The money you withdraw from your traditional 401(k) plan is taxed as regular income in the year you withdraw it - like income from a job. You may be required to pay a 10% penalty if you cash out a traditional 401(k) before age 59^1/2 (unless you qualify for an exception). If you wait too long to withdraw from retirement accounts (after age 72), you may also have to pay a penalty.