Investments can be be taxed in several ways. When they are held inside retirement accounts, taxes are levied upon withdrawals from the retirement accounts based upon the rules related to those accounts. When they are held outside of retirement accounts, they can be taxed on both the income which the investments generate as well as on the gains obtained when the investments are disposed of.
We restrict discussion to dividends and interest here, and how they are treated for the recipient. Income paid in the form of dividends and interest is typically taxable to the recipient upon being paid by the issuer or payer. In the case where dividends are reinvested to purchase additional securities the dividends are still taxed upon being paid. Dividends and interest are typically taxed as ordinary income, the exception being certain “qualified” dividends which are taxed at the capital gains tax rate.
Capital gains taxes are incurred when an asset is disposed of, and are based upon the amount of time which the asset is held. Assets held for one year or less are taxed at the short term capital gains tax rate, while assets held for more than one year are taxed at the long term capital gains tax rate. The amount of the gain is a function of the sales price and the cost basis of the asset. The table below shows the capital gain tax rates for their corresponding income tax bracket.
|Income tax bracket||short term rate||long term rate|