Taxes on investment income can be confusing, especially since there are several ways investment income is taxed. An investor may be familiar with capital gains taxes—the taxes imposed when one sells an asset that has grown—but less clear on the implications of dividends, interest, and other ways in which investments have tax implications.
Dividends are distributions that are sometimes paid to investors who hold a stock or otherwise have an interest in a partnership, trust, S-corp, or other entity taxable as a corporation. Dividends are generally paid in cash, out of profits and earnings from a corporation.
Capital gains are the profit an investor makes between the price of an asset when purchased, versus the price of an asset when sold. Capital gains taxes are the taxes levied on the net gain between purchase price and sell price.
The Net Investment Income Tax (NIIT), now more commonly known as the “Medicare tax,” is a 3.8% flat tax rate on investment income for taxpayers whose adjusted gross income (AGI) is above a certain level—$200,000 for single filers; $250,000 for filers filing jointly.
One way to mitigate the effects of investment income is to create a set of tax-efficient investing strategies. These are strategies that can minimize the tax hit that you may experience from investments and allow you to grow your wealth.