It’s nice to own stocks, bonds, and other investments. Nice, that is, until it’s time to fill out your federal income tax return. At that point, you may be left scratching your head. Just how do you report your investments and how are they taxed?
Is it ordinary income or a capital gain?
To determine how an investment vehicle is taxed in a given year, first ask yourself what went on with the investment that year. Did it generate interest income? If so, the income is probably considered ordinary. Did you sell the investment? If so, a capital gain or loss is probably involved. (Certain investments can generate both ordinary income and capital gain income, but we won’t get into that here.)
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. Dividends paid to an individual shareholder from a domestic corporation or qualified foreign corporation are generally taxed at the same rates that apply to long-term capital gains. Long-term capital gains and qualified dividends are generally taxed at special capital gains tax rates of 0 percent, 15 percent, and 20 percent depending on your taxable income. (Some types of capital gains may be taxed as high as 25 percent or 28 percent.) The actual process of calculating tax on long-term capital gains and qualified dividends is extremely complicated and depends on the amount of your net capital gains and qualified dividends and your taxable income. But special rules and exclusions apply, and some dividends (such as those from money market mutual funds) continue to be treated as ordinary income.
The distinction between ordinary income and capital gain income 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
Investments often produce ordinary income. Examples of ordinary income include interest and rent. Many investments — including savings accounts, certificates of deposit, money market accounts, annuities, bonds, and some preferred stock — can generate ordinary income. Ordinary income is taxed at ordinary (as opposed to capital gains) tax rates.
But not all ordinary income is taxable — and even if it is taxable, it may not be taxed immediately. If you receive ordinary income, the income can be categorized as taxable, tax exempt, or tax deferred.
- Taxable income: This is income that’s not tax exempt or tax deferred. If you receive ordinary taxable income from your investments, you’ll report it on your federal income tax return. In some cases, you may have to detail your investments and income on Schedule B.
- A quick word about ordinary losses: It’s possible for an investment to generate an ordinary loss, rather than ordinary income. In general, ordinary losses reduce ordinary income.
Understanding what basis means
Let’s move on to what happens when you sell an investment vehicle. Before getting into capital gains and losses, though, you need to understand an important term — basis. Generally speaking, basis refers to the amount of your investment in an asset. To calculate the capital gain or loss when you sell or exchange an asset, you must know how to determine both your initial basis and adjusted basis in the asset.
First, initial basis. Usually, your initial basis equals your cost — what you paid for the asset. For example, if you purchased one share of stock for $10,000, your initial basis in the stock is $10,000. However, your initial basis can differ from the cost if you did not purchase an asset but rather received it as a gift or inheritance, or in a tax-free exchange.
Next, adjusted basis. Your initial basis in an asset can increase or decrease over time in certain circumstances. For example, if you buy a house for $100,000, your initial basis in the house will be $100,000. If you later improve your home by installing a $5,000 deck, your adjusted basis in the house may be $105,000. You should be aware of which items increase the basis of your asset, and which items decrease the basis of your asset. See IRS Publication 551 for details.
Calculating your capital gain or loss
If you sell stocks, bonds, or other capital assets, you’ll end up with a capital gain or loss. Special capital gains tax rates may apply. These rates may be lower than ordinary income tax rates.
Basically, capital gain (or loss) equals the amount that you realize on the sale of your asset (i.e., the amount of cash and/or the value of any property you receive) less your adjusted basis in the asset. If you sell an asset for more than your adjusted basis in the asset, you’ll have a capital gain. For example, assume you had an adjusted basis in stock of $10,000. If you sell the stock for $15,000, your capital gain will be $5,000. If you sell an asset for less than your adjusted basis in the asset, you’ll have a capital loss. For example, assume you had an adjusted basis in stock of $10,000. If you sell the stock for $8,000, your capital loss will be $2,000.
Schedule D of your income tax return is where you’ll calculate your short-term and long-term capital gains and losses, and figure the tax due, if any. You’ll need to know not only your adjusted basis and the amount realized from each sale, but also your holding period, your taxable income, and the type of asset(s) involved. See IRS Publication 544 for details.
- Holding period: Generally, the holding period refers to how long you owned an asset. A capital gain is classified as short term if the asset was held for a year or less, and long term if the asset was held for more than one year. The tax rates applied to long-term capital gain income are generally lower than those applied to short-term capital gain income. Short-term capital gains are taxed at the same rate as your ordinary income.
- Taxable income: Long-term capital gains and qualified dividends are generally taxed at special capital gains tax rates of 0%, 15%, and 20% depending on your taxable income. (Some types of capital gains may be taxed as high as 25 percent or 28 percent.) The actual process of calculating tax on long-term capital gains and qualified dividends is extremely complicated and depends on the amount of your net capital gains and qualified dividends and your taxable income.
- Type of asset: The type of asset that you sell will dictate the capital gain rate that applies, and possibly the steps that you should take to calculate the capital gain (or loss). For instance, the sale of an antique is taxed at the maximum tax rate of 28 percent even if you held the antique for more than 12 months.
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 ($1,500 for married persons filing separately). 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 percent Medicare contribution tax on unearned income (the tax, which first took effect in 2013, is also imposed on estates and trusts, although slightly different rules apply). The tax is equal to 3.8 percent of the lesser of:
- Your net investment income (generally, net income from interest, dividends, annuities, royalties and rents, and capital gains, as well as income from a business that is considered a passive activity), or
- The amount of your modified adjusted gross income that exceeds $200,000 ($250,000 if married filing a joint federal income tax return, $125,000 if married filing a separate return)
So, effectively, you’re subject to the additional 3.8 percent tax only if your adjusted gross income exceeds the dollar thresholds listed above. It’s worth noting that interest on tax-exempt bonds is not considered net investment income for purposes of the additional tax. Qualified retirement plan and IRA distributions are also not considered investment income.
Getting help when things get too 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 properly calculate your capital gain or loss. Also, remember that you can always seek the assistance of an accountant or other tax professional.
Have a fantastic weekend!
Golf Tip of the Week
3 ways to check your “golf mobility”
If you’re looking to identify the cause of your golf struggles, it’s natural to think the cause is a fault in your swing. “But sometimes the fault isn’t the cause, it’s a symptom,” says Golf Digest fitness advisor Ben Shear. Sometimes poor shots are the result of a physical dysfunction that causes poor swing mechanics. The symptoms: poor contact with the ball even when you’re consciously trying to hit it solid; struggling to swing the club through the impact zone without straightening up; and routinely pulling shots left of your target or slicing them right of it—or both. If any of these describe the state of your game, stand with your back to a wall and take these three physical screening tests to see if you lack the muscle function necessary to hit great shots.
TEST NO. 1
Stand with your upper body against a wall and your feet angled about 12 inches from it. Make sure your pelvis is tucked under your torso. Extend one arm so it’s perpendicular to the wall and raise it over your head without bending it. The goal is to touch the wall while maintaining the body’s other contact points. Repeat the test with the other arm.
IF YOU FAILED: The inverted triangular-shaped muscle of your upper back, known as the latissimus dorsi or “lat,” is too tight. This causes your swing to be short and narrow, resulting in thin and fat shots and/or slices. To improve mobility, lie on your side, leaning back slightly on a foam roller. Roll from hips to armpits for three minutes a few times a week. Also, stretch your upper-back muscles before you play.
TEST NO. 2
Stand against the wall just like you did in Test No. 1 and extend both arms at the same time, pressing the palms together. Raise both arms over your head. The goal is to touch the wall with your two thumbs without arching your lower back or losing any of the contact points created when you began the test.
IF YOU FAILED: The muscles around the thoracic spine (mid-back) aren’t functioning properly. This causes a loss of posture and limits your ability to rotate when you swing. Lie on a foam roller, and move it up and down your back. Stop in the middle and let your shoulders gently sink toward the floor while keeping your butt on the ground. Also, strengthen your oblique muscles with exercises like side planks and seated torso rotations.
TEST NO. 3
Stand with the majority of your body—from heels to head—against the wall. Bend one arm 90 degrees, and place the upper portion of the arm against the wall at shoulder height. Now raise the lower portion of the arm, maintaining the 90-degree angle. Your goal is to touch the wall with the back of your hand while keeping the bottom part of your back from arching or pressing into the wall.
IF YOU FAILED: Shoulder mobility is an issue for you, and this likely causes you to hit shots fat, thin or your path into the ball is noticeably out-to-in (slices/pulls). Work on stretching the pectoral muscles (chest) and exercises that improve the external rotation of the shoulder joint. Even repeating this test can improve mobility.
Tip adapted from golfdigest.comi
Recipe of the Week
Spicy Lasagna Soup
- 2 tablespoons extra virgin olive oil
- 1 yellow onion, chopped
- 1/2 cup chopped, celery
- 2 red bell peppers, chopped
- 6 cloves garlic, chopped
- 1/2 pound ground beef, bison, or chicken
- 1/2 pound spicy Italian sausage
- 1 tablespoon dried basil
- 1 tablespoon dried oregano
- 2 teaspoons dried thyme
- 1/2 teaspoon red pepper flakes
- 1/2 cup tomato paste
- 1/2 cup dry white wine
- 4 cups low sodium chicken broth
- 1 can (28 ounce) crushed tomatoes
- 1/2 cup canned coconut milk, milk, or cream
- 1 cup shredded provolone cheese
- 1/2 cup grated parmesan
- 8-12 lasagna noodles, broken into pieces
1.Heat the olive oil in a large dutch oven over high heat. Add the onion, celery, and red pepper, and cook until the veggies are softened, about 5 minutes. Stir in the garlic and cook 1 minute.
2. Add the meat and sausage. Season with salt and pepper. Cook, breaking up the meat as it cooks, until browned all over, 10 minutes. Add the tomato paste, basil, oregano, thyme, and chili flakes and cook 5 minutes, then pour in the wine. Add the crushed tomatoes and broth. Season with salt and pepper. Cook 10-20 minutes until thickened slightly.
3. Stir in the milk and cook until warmed through, 10 minutes.
4. Meanwhile, boil the noodles until al dente. Drain and add back to the pot with the cheeses. Ladle the soup into bowls and serve topped with parmesan and fresh herbs.
Recipe adapted from halfbakedharvest.com[ii]
Health Tip of the Week
The 17 Best Foods to Lower (or Regulate) Your Blood Sugar
For people with prediabetes, diabetes, or other conditions that affect blood sugar, diet is a major part of maintaining healthy blood sugar levels.
Although factors like body weight, activity, stress, and genetics also play a role in blood sugar maintenance, following a healthy diet is critical for blood sugar control.
While some foods, including items high in added sugar and refined carbs, can contribute to blood sugar fluctuations, others can optimize blood sugar control while promoting overall health.
Here are 17 foods that may help regulate your blood sugar.
- Broccoli and broccoli sprouts
- Pumpkin and pumpkin seeds
- Nuts and nut butter
- Flax Seeds
- Beans and lentils
- Kimchi and sauerkraut
- Chia seeds
- Oats and oat bran
- Citrus fruit
- Kefire and yogurt
Tip adapted from healthline.comiii
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