Taxes and IRAs Flashcards
(44 cards)
Who collects taxes for the US government?
- The IRS
What is the Progressive tax category?
Taxes that hit higher income earners harder than lower income earners. These taxes include income, gifts, and estate taxes.
More likely to be questions on SIE.
What is the Regressive tax category?
Taxes that hit the lower income earners harder than higher income earners. These include sales tax, payroll taxes, property taxes, excise taxes, gas taxes, etc
Types of income - Earned income
What is it and how is it taxed?
Income that is reported on a W-2 such as wages, salary, bonuses, tips, and commissions.
Earned income is taxed at the individuals tax bracket (between 10-37%).
Subject to Federal, state (if applicable), and FICA (SSN + Medicare).
Types of income - Passive income
What is it and how is it taxed?
Income from non-direct participation such as owning rental property, royalties, or being part of a DPP.
DPP losses can be written against the passive income
Passive income is subject to federal income tax and possibly NIIT (Net investment income tax) for higher income individuals
○ Not subject to FICA (SSN + Medicare)
Rental income is taxed as ordinary income
Capital gains/dividends may be taxed lesser.
Types of income - Portfolio Income
Income from interest, dividends, and capital gains derived from the sale of a security. This income is taxed at the investors tax bracket (income rate) or lower rate.
Portfolio Income - Interest income
Definition
Examples
Taxed as
Subject to
Example
Income earned from the interest derived from Debt securities
Example securities: Corporate Bonds, Mutual Funds invested in debt securities. Savings accounts, US treasury bonds, Municipal Bonds.
Taxed as: Ordinary Income
Subject to: Federal, State tax (unless tax exempt bonds like municipal bonds), Not subject to FICA (Medicare plus SSN)
Example - You earned $500 from a corporate bond which is taxed as ordinary income.
How is Corporate, Municipal, and US Gov debt securities Interest income taxed?
○ Corporate bond interest is taxed at all levels (Federal and local)
○ Municipal bond interest is typically Fed exempt and taxable at the local level unless the investor lives in that municipality.
○ US Government Treasury bonds is taxed at the Federal level and exempt at the municipal level.
Even though T-bills and T-STRIPS don’t pay out interest, the difference in the discount paid and par maturity received is taxable
What type of dividends can be received by an investor?
Cash, stock, or product
Portfolio income - Cash Dividends
Definition
Examples
Taxed as
Subject to
Example
Income earned from the dividends paid by Equity securities. There are qualified and non-qualified Dividends.
Example securities: Common stock, Preferred stock, Mutual funds, ETFs, REITs, etc
Taxed as: Ordinary or Qualified
Ordinary: Taxed at regular income bracket
Qualified: Taxed at long term cap gains rate (0%, 15%, 20%) must meet holding period 61 days prior to ex-dividend date.
Ex: $1000 qualified dividends may be taxed at 0-15-20% depending on your bracket.
Portfolio Income - Stock Dividend
Stock dividends are not taxed (since the value of the investment is not changed) instead the cost basis lowers the cost basis per share. The cost basis is used to calculate the capital gains and losses.
Total cost basis remains the same but the per share basis is reduced
Portfolio Income - Dividends from mutual funds
Taxed as qualified or non-qualified
□ Qualified - taxed at a lower rate (0, 15 ,20) must of held to securities for 61 days prior to ex-dividend date.
□ Non-qualified - taxed at ordinary income tax bracket.
Which mutual fund investment dividends/interest is federal tax free?
Municipal Bonds
Which is taxed at 0, 15, 20%?
Common Stock
Long term capital gains
Which mutual fund investment dividends/interest taxed as ordinary income?
Corporate bond funds
Short term capital gains
What is one unique thing that Mutual funds do at the beginning of the year?
In January they send each investor (and the IRS) a statement letting you know how much in dividends, short term cap gains, and long-term capital gains you received.
Who determines the short term and long-term capital gains within a mutual fund and why?
The mutual fund determines the short- and long-term cap gains by the holding period (how long they held a security within the fund) not by how long the investor had the mutual fund shares.
What are mutual fund investors subject to every year?
Mutual funds are subject to taxes on dividends and capital gains even if the money is reinvested.
What are Capital Gains/Loses?
Capital gains are profits (realized profits) when selling a security
Ex - Bob buys TSLA shares valued at 4000 then sells at 6000, the 2k difference is taxable at the cap gain rates.
Capital losses are losses incurred when selling a security at a loss (realized losses)
How do you determine if an investor had a capital gain/loss?
If an investor conducted a sale one of two things happens depending on their cost basis
Cost basis is lower than their sale price = Capital Gain
Cost basis is higher than their sale price = Cap loss
The cost basis includes the purchase price and any commissions/fees.
Cost basis remains unchanged unless…
Unless there’s a stock split, stock dividend, accretion, amortization, etc
◊ Accretion - when an investor purchases a bond above PAR
◊ Amortization - when an investor purchases a bond below PAR
Cost per share goes down but the overall cost basis does not change
When are capital gains realized and at what level are they taxed?
When an investor sells a security for a higher price than their cost basis.
Cap gains on any security (even muni bonds and US Treasury Bonds) are taxed at the Federal, state, and local level.
Long term 0, 15, 20% depending on tax bracket
Short term - Ordinary income tax rate
What happens with the appreciation if a security is held and not sold?
During the appreciation (security price rising) if not sold this is considered an unrealized gain
If the investor DOES NOT SELL, they don’t incur a capital gain, their gains stay unrealized.
What are the two categories for Cap gains and how is each taxed?
Short term cap gain - Taxed at the investors tax bracket (ordinary), short term is considered holding the security for one year or less
Long term cap gain - Taxed at 0 , 15, 20% depending on the investors AGI (adjusted gross income), are considered long if the investor holds on to shares for longer than a year.
