Investment Income Tax Law

A close up picture of some U.S. currency to represent investment income

An investment in knowledge pays the best interest, but it never hurts to see the extra cash that an investment in a financial asset can make. But while the IRS won’t tax the time you spend reading, they will take their share of the income you make from your financial investments. In this article, we’ll discuss some of the areas of Investment Income and the taxation rules associated with each of them.

Interest Income

Though usually a small amount compared to your annual gross income, any liquid interest that you receive is taxable interest. This means that any interest that is deposited directly into your bank account, or that is easy to withdrawal, is taxable. Financial institutions, like your bank, should give you a Form 1099-INT detailing the amount of interest income you earned with their institution.

If the earned interest is not liquid or difficult to access, such as money that is locked away in a Certificate of Deposit (CD) or an Individual Retirement Arrangement (IRA), then that interest income is classified as tax deferred. This means that you don’t have to pay taxes on it the year that it is paid to the account, but you will eventually pay taxes on it when you withdrawal that money.

There are some other forms of income that the IRS classifies as interest income, such as interest made on a personal loan. If you open an account and receive a cash or non-cash gift as a reward or incentive, you may have to report the value of those gifts as interest income. If you have a prepaid insurance premium, and the value of that prepaid premium is increased, that counts as interest income.

Dividends

One of the best reasons to purchase preferred stock is that holders of preferred stock are the first to receive dividends from a company at the end of its fiscal year. A dividend is a payment to shareholders of a company. Each company sets its own policies for distributing dividends, but they are all taxed the same way.

Much like banks, corporations should provide you with a Form 1099-DIV to show you how much they paid you in distributions. If a corporation doesn’t provide one of these forms, you are still obligated to pay taxes on dividends if you receive them. Most of the time, the dividends you receive are ordinary dividends, and these are taxed like regular income. They are not capital gains, unless the dividends are Qualified Dividends.

For a dividend to be a Qualified Dividend, you must have received it from a US corporation or qualifying international corporation, held on to it for a specific holding period, and the dividend must not meet some other exception. A qualifying international corporation must be traded on a US securities market or be from a country that is in a country with which the United States has a tax treaty with. This includes Canada, Mexico, and most European countries, except for the central Balkans, among others. Though the difference may be confusing, it’s important to recognize the differences between the two dividend types, as Qualified Dividends are taxed at the lower capital gains tax rate.

Regardless of how you spend the money earned from dividends, you must still report them as income, even if you reinvest your dividends into more stock. If you receive dividends from a mutual fund or real estate investment trust they are reported as long-term capital gains.

Conclusion

Has the IRS wrongfully collected additional tax dollars from you? Contact Cornerstone Law Firm today. The attorneys are experienced in tax law and can help you appeal a decision by the IRS. You have a right to challenge an IRS opinion with an attorney by your side, so don’t hesitate to contact us if you’ve been wronged.