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Knowing how you need to file your taxes depends on your income and filing status, as well as which deductions and credits you can claim. In this free ebook, we share some common errors to avoid.

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Anatomy of a tax return (Part 3) - Investment related income

February 04, 2023

Investment related income usually involves interest, dividend and capital gains related income and these show up on Lines 2, 3 and 7 of the 2021 Form 1040.  Capital gains from other activities such as selling business property can also show up on Line 7.

Many people plan their paycheck tax withholdings to cover their paycheck income but forget that there are other types of income that is often not planned for.  Often the amount of investment income that you will be taxed on at year end is not known until year end or even after year end which can make planning for it difficult.

One thing that you can do though is monitor your monthly and quarterly investment statements during the year as they can be an indicator of what taxable income might be coming at year end and then possibly you can plan for that income through higher withholding from your paycheck or make estimated tax payments.

As an example of this monitoring during the 2021 tax season a client knew in advance that in their taxable investment account that they were going to have to record investment related income of and pay tax on about $50,000 of dividends even though they had not done a single action to cause that event to happen.

Due to some action taken by one of their investments during the year they found out they were going to receive at least $50,000 in taxable dividend and were able to plan for that tax event before the end of 2021.

This discovery came about simply by reviewing their monthly investment statement and observing a much larger change in dividends than they were used to seeing.

Also note that they did not actually get that dividend in the form of a direct payment to them.  If you have a taxable account (for example a non-retirement account normally) the income on that account is taxable each year and even if you have your dividends reinvested that is still taxable income to you in most cases.

A more complicated issue and sometimes even harder to predict is capital gains.  For example you may own a mutual fund which itself owns the stock of many companies within its portfolio.  As it buys and sells its own investments it generates capital gains that are then passed on to its investors (you). 

Quite often those don’t get recorded until December so often you the owner of that mutual fund may not find out until after year end and had no time to plan for the potential tax effect.  When you get your annual Form 1099-B statements you should immediately look at those as it could give you an advance clue as to your potential tax return results instead of waiting until closer to the tax filing deadline and then getting a surprise.

It happens often we see at tax return time that a taxpayer owes tax and its due to unexpected investment income so pre planning during the year is critical to try and minimize surprises at tax return time.

If you’ve decided that you need a tax and financial plan to improve your financial health let’s set up a call.

The information in this and other articles is intended to be educational in nature only.  Not tax, legal or investment guidance for you specifically.  Each person’s situation is unique and you must seek appropriate professional guidance that can address your unique situation.

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