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TAX TALK: Which income investment is not like the others?

Posted by Hal Zemel, CPA, J.D., LL.M. on Oct 5, 2015 7:00:00 AM
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While tax consequences should not be the primary consideration for investment decisions, they should be taken into account to maximize after tax returns. Depending on your risk profile, you may be interested in long-term capital appreciation or a dependable current income stream.  Growth stocks and mutual funds may provide long-term capital appreciation with less current income. For those favoring a current income stream, you have various choices including US Treasury Bonds/Bills, state and local bonds, corporate bonds, certificates of deposit (CDs), and dividend paying stocks.

A quality growth mutual fund allows you to defer most of the income on appreciation until you dispose of the fund. If you hold the fund for more than one year, the gain will be taxed at preferential long term-capital gains rates, typically 15% or 20%. Qualified dividends and capital gain dividends will likewise be taxed at capital gain rates.
US Treasury bonds/bills provide interest income that’s exempt from state taxation, but are taxed federally as ordinary income at rates as high as 39.6%.
State and local bonds earn interest that’s exempt from both federal and resident state tax, if the bond is issued by your resident state. However, beware of private activity bonds that are not federally tax-exempt if you’re subject to the alternative minimum tax.
Bonds, CDs and other interest bearing accounts are taxed as ordinary income and subject to state taxes.

With the exception of state and local bonds, all investment income will be subject to net investment income tax at an additional 3.8%.

When deciding between dividend paying stocks and mutual funds, note that some dividends aren't qualified and are subject to ordinary income rates.  Dividends in this category include:

Real estate investment trusts (REITs);
Certain regulated investment companies (RICs);
Money market mutual funds; and
Certain foreign investments.

Questions? For assistance factoring tax treatment into your investment strategy, please contact us. contact us.

Hal Zemel, a Tax Principal at Berdon LLP, has more than 20 years in public accounting and advises businesses in the real estate, service, and manufacturing sectors. 

Topics: TAX TALK

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