Investing and Tax Considerations

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					Investing and Tax
Investing and Tax Considerations

Managing the tax implications is a hallmark of good investing. But let's face it,
investing can be complicated and taxes are always complicated. Putting them both
together doesn't make it any easier. This article covers the basics, so you can keep as
much of your investment earnings as possible.

Tax efficiency is simply how much of an investment's return still remains after all the tax
obligations have been taken care of.

A good general rule to remember is that the more an investment's return is
dependent on income rather than an increase in share price, the worse the tax
burden usually is, or the less tax efficient it is.

Taxable or Non-Taxable

Investment accounts are classified as either taxable or non-taxable. If an account is
taxable, then the taxes must be paid on investment income in the same year in which
it is received. This would include bank accounts, money market mutual funds, and
your basic individual or joint investment account.

Non-taxable accounts are free from taxes as long as the money stays in the account.
When you start taking money out, your tax liabilities kick in. This would include any
type of retirement account, like your 401(k) and IRA.

A good rule to follow is to use your non-taxable accounts for the less efficient
investments and the taxable accounts for the more efficient investments.

The Effect of Your Tax Bracket

If you're going to invest with taxes in mind, be aware of your tax bracket. You must
determine your marginal income tax bracket and also whether or not you're subject
to the alternative minimum tax. The higher your tax bracket, the more important it is to
be in tax efficient investments.

Current Income versus Capital Gains

There are also differences between taxes on current income and taxes on capital
gains. Any current income is usually taxed at your tax bracket rate.

Capital gains are categorized as either short-term or long-term. Short-term
investments are those held less than a year; long-term would be anything longer than
a year. Typically, short-term gains are taxed as income and long-term gains are at the
preferential rate.

Tax Treatment for Typical Investments

Consider these tax treatments for the investments you're considering:

     Dividends are normally taxed at a lower preferential rate. So dividends are
     likely to be a better for an investor in a higher tax bracket than for one in a
     lower bracket.

     Bonds provide interest and are usually taxed at the marginal (income tax
     bracket) rate. This would not be a tax efficient investment for someone in a
     higher tax bracket.

     The gains realized from stocks that are held for over a year and then sold would
     be taxed at the preferential rate.

     Some investments with poor tax efficiency would include junk bonds and
     preferred stock. This is due to the high interest received and the high, fixed
     dividends that are received, respectively.

     High tax efficiency investments would include stocks and municipal bonds.
     Municipal bonds are not taxed at the federal level and the yields are quite low.

                                        Stocks are typically held for more than a year, so the gains are taxed at the
                                        preferential rate. Both can be held in retirement accounts, which would make
                                        them even more tax efficient.

                                   Minimizing the tax burden on investments is well within the reach of any investor, even
                                   beginners. Simply take a look at your marginal tax bracket and the preferential tax
                                   rate and make a plan. If your marginal tax rate is relatively low, you have a lot more
                                   flexibility. If it is high, then more planning will really pay off.


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