Posted on January 7, 2019
Today’s Letter from Grandma Sylvia
A friend asked me why she has to pay taxes on her investments. I know it’s not yet tax time, but I’ll write about taxes now because of her question and because it’s time many of us start organizing our paperwork for that looming deadline of April 15.
Paying taxes is a topic many of us would like to avoid and I’m one of them. However, I don’t want to avoid being clear that what you read here are my experiences and what I’ve learned and believe. Consulting tax professionals and/or financial professionals are what investors need to do to determine what’s in their own best interests. Tax laws are complicated and it’s best to get specific advice from a tax expert.
The Big Picture
Would there ever have been a United States of America but for the increased taxes the British government levied on the colonists? There was the Sugar Act, the Currency Act, the Quartering Act, the Stamp Act, and finally the Tea Act.
From those beginnings, many Americans have had an uneasy feeling about taxes.
Of course, as we well know, taxes didn’t disappear from the US scene once independence was declared. There were taxes on
- Glass windows
- Poll taxes on voters
- Property taxes
- Excise taxes (paid on the purchase of specific goods), and
- Income taxes.
The income tax, put into law in 1909 in the 16th Amendment to the Constitution, states:
The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.
As investors, it’s the income from our investments that is taxed.
Here are some quotes I like about taxes:
The hardest thing in the world to understand is the income tax.
The only difference between death and taxes is that death doesn’t get worse every time Congress meets.
The avoidance of taxes is the only intellectual pursuit that carries any reward.
John Maynard Keynes
It’s income tax time again, Americans: time to gather up those receipts, get out those tax forms, sharpen up that pencil, and stab yourself in the aorta.
I’m proud to pay taxes in the United States; the only thing is, I could be just as proud for half the money.
Unquestionably, there is progress. The average American now pays out twice as much in taxes as he formerly got in wages.
Beyond saving, saving, saving, I had to learn how to invest and what impact taxes had on my investments.
I quickly learned that if I made any money (dividends or interest) from my market assets (e.g., funds, stocks, or bonds) or if I sold any of these and the value was more than I initially paid (i.e., capital gains), then there would be taxes on those gains. Losses were accounted for also, on my tax returns. Sometimes losses offset gains so taxes were minimized, but by and large I pay taxes every year and use a good tax preparer to be sure I do it right
Today’s Topic: Taxes from Investments
As investors, we generally have to pay taxes on what we’ve earned from our investments. We read stories about very wealthy people who seem to pay little or no taxes, but for most of us we don’t have the wealth that allows us to take those actions.
Investing in traditional Individual Retirement Accounts (IRAs) means deferring paying taxes until the money is withdrawn. Then the principal and any income would grow tax-free, normally until age 70 1/2 when withdrawals are mandatory. The theory is that once retired, income would be less and, thus, the income tax rate would be less. Any money withdrawn from an IRA is based on the person’s current income tax rate. Because the principal was not taxed when the money was put into the IRA, any withdrawal is taxed.
On a Roth IRA, income taxes are paid before the money is put into the Roth IRA, so normally there is no tax on the money withdrawn and no mandatory retirement age.
For ordinary taxable accounts, we pay taxes on all our income based on the current tables set by the IRS.
Taxes are paid on interest, dividends, and short-term and long-term capital gains. Short-term capital gains occur when an asset is held less than a year and then sold for a profit. If an assset is held for a year or more and sold for a profit, then long-term capital gains occur at a lower tax rate.
Different tax rates are also in effect for qualified and non-qualified dividends. Much is written about this for the interested investor.
With changing tax laws, and qualifications, it’s best to check any tax questions with a qualified tax professional who keeps current with the laws.
A final word, as a friend said, “Don’t make investment decisions based on tax avoidance. A realized gain of 85% beats zero, even with a 15% capital gains tax.”
♦ Taxes are inevitable. It is wise to be prepared and get qualified advice about taxes
Now I’m going to look at some of the papers I need for tax season. Wish you were here.
Am thoroughly enjoying your insights on investing. Your blog I truly feel is an answer to my prayers. Also I forgot to mention that I was named after my Mom’s Mom, Sylvia Reynolds ! 🙂 Have a wonderful day and God Bless.