Taxes On Investments

Investors are subject to a variety of taxes on investments, based on the type of returns received.

Ordinary Income Taxes
Some sources of investment income — primarily interest income from corporate and U.S. government bonds — are subject to taxation at ordinary income tax rates. Over the past 30 years, the highest marginal tax rates have ranged from 28% to 50%. In prior periods, the highest marginal rate reached as high as 70%. Clearly, higher marginal tax rates impact the amount of interest income one retains.

The interest income from municipal bonds is generally not subject to ordinary income taxes.  Recently municipalities have begun issuing taxable bonds.  In addition, most states levy a state income tax on bonds issued by other states.

Dividend Income Taxes
For many years, interest income from taxable bonds and dividend income from equities were taxed at the same rate. Legislation signed in 2003 changed the rules so that the maximum rate on certain types of dividend income is now 15%. This legislation could expire soon, and the tax rate on dividend income could increase in coming years.

Capital Gains Taxes
The third type of tax applies to capital gains — the difference between the price paid for an investment and the higher price at which it was sold. As with other tax types, these rates vary over time. Individuals pay capital gains taxes at ordinary income tax rates for gains on investments held less than 12 months. In 2003, the capital gains rate paid on securities held longer than 12 months was lowered from 20% to 15%. This legislation could expire soon as well.

“Real” returns should be calculated after taxes and inflation.  Tax awareness is something that we practice at all times.


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