Tax Planning

calculator on a pile of money

In summary, taxes stink. So it is good to know how they work and how you can avoid them in cases where you are able to do so. Due to the complexities of the IRS tax code this section could be a website by itself, so what follow is a brief focus on how the tax code applies to young professional readers.

First – let’s start off with your income taxes. Income taxes are set up on a marginal schedule where different levels of income are taxed at different rates.

Your income is taxed on a waterfall effect so that each level of income is taxed at its respective rate. For example: If you aren’t married and make $50,000 per year in taxable income (your income that is left after deductions and exemptions) from $0 – $9,950 is taxed at 10%, income from $9,951 – $40,525 is at 12%, and $40,526 and above is taxed at 22%. Thus on your entire income, you will pay $6,748 in federal income taxes, leading to your effective overall federal tax rate of 13.5% ($6,748 / $50,000).

Here are the current brackets for the 2021 tax year:

MARGINAL TAX RATE SINGLE MARRIED FILING JOINTLY
10% $0-$9,950 $0-$19,900
12% $9,950-$40,525 $19,900-$81,050
22% $40,525-$86,375 $81,050-$172,750
24% $86,375-$164,925 $172,750-$329,850
32% $164,925-$209,425 $329,850-$418,850
35% Over $209,425 Over $418,850

States have income tax rates ranging from 0 to as high as 13.3% with different tax brackets. The Tax Foundation has detailed notes on state-specific tax levels.

You may be able to take deductions from your income with the most common deductions being for: Interest payments on your home mortgage, student loan interest payments (if your income is beneath certain limits), state and local taxes paid (limited to $10,000 for tax years 2018 to 2025), and charitable gifts (subject to income limitations), to name a few. Due to the complexity of the tax code, the legal risk if you file a faulty return and the monetary impact of not realizing all of your deductions, it may be wise to fork over the money to a Certified Public Accountant (CPA) to file your tax return on your behalf (not the H&R Block office, but the local accountants office… ask a friend for a referral).

More in tune with the theme of this website is knowing how your new investments are going to be taxed. Below is a table that breaks down seven of the likely federal tax events you will encounter in the investment world (though hopefully avoiding a few of them):

Investment Tax Event Description Tax Rate
Long-Term Capital Gains This tax applies to you when you sell a stock or bond investment you held for more than a year at a price above where you bought it. 0 percent if you are in the 10 or 12 percent marginal federal tax bracket. Rates then range from 15 up to 23.8 percent based on income.
Short-Term Capital Gains Sales of a stock or bond investment held for under a full year receive a higher tax rate to encourage long-term investing. Income is taxed at your marginal tax rate.
Qualified Dividends Any dividend payment you receive from your stock investments are taxed. 0 percent if you are in the 10 or 12 percent marginal federal tax bracket. Rates then range from 15 up to 23.8 percent based on income.
Interest and Ordinary Dividends Any interest you receive on a fixed income instrument like a bond (excluding municipal bonds), Certificate of Deposit (CD) or a money market instrument. Income is taxed at your marginal tax rate.
Interest on Municipal Bonds Interest received on a municipal bond (state or locally issued debt) is exempt from federal, and in most cases, all state taxes if the bondholder lives in that state. Interest income is exempt from federal tax.
Long-term Collectibles Collectibles This rate applies to collectibles (including art, antiques, coins, etc. but more importantly any gold or silver investments) held for more than one year. 28 percent flat tax.
Real Estate If you sell your primary residence (not your glamorous beach vacay home but the house you normally live in) that you have lived in two of the last five years then you get a wicked tax break. All gains on the sale of your home up to $250,000 are tax-free; $500,000 if you are married.
  • Note that taxation on long-term equity investing (which includes long-term capital gains and qualified dividends received) receive a tax benefit over fixed income (whose return is primarily through interest payments) and silver/gold investments.
  • By following our “long-term” mantra you will likely lower your tax rate by 5 to 8% if you sell your stocks after you hold them for a year instead of trading them frequently and realizing short-term gains.
  • If you do sell a stock investment at a loss you can deduct that loss from a future gain and thus not pay a tax on that portion of your gain.
  • Gains, dividends or interest on investments in your retirement accounts (IRA or 401k) are not taxed until the funds are distributed retirement (unless you have a Roth account where all of your returns are tax-free in retirement since there is no tax on Roth IRA distributions).
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All information included in this page and all pages throughout Young Money, Smart Money is provided for informational and educational purposes only and should not be taken as investment advice or a recommendation to invest accordingly. Investing involves risk, including a potential for a loss of principal. Educate yourself about all investments and funds you purchase, including their risks, objectives, and fees and expenses before investing. For additional assistance, please contact us or another financial professional for a more detailed review of your specific situation.