TAXES

INVESTING AND TAXES

How does the IRS define an investor?

The IRS defines an investor as anyone who buys and sells securities for the purpose of generating income from dividends, interest, and/or capital appreciation. As long as you are not conducting a trade or business with these securities, the IRS considers you an individual investor.

What types of factors do investors normally consider when trying to choose between tax-exempt and taxable investments?

Investors often have to choose between investing in tax-exempt securities such as municipal bonds, and taxable investments such as equities. But because of the tax-free nature of certain investments, investors are willing to part with higher returns in order to take advantage of the lower tax consequences of tax-free investing. So each individual's tax status may determine how attractive a tax-exempt investment may be.

How do I compare the yields of tax-exempt investments and their taxable investment equivalents?

You may compare the difference between the yields of tax-exempt investments and taxable investments by performing a calculation. First, find the yield of your tax-exempt investment (say 5%). Then subtract your tax bracket from one, and express it as a decimal (if your tax bracket is 25%, then 1.0 minus 0.25 equals 0.75). Then divide the tax-free yield by the tax bracket computation (5% divided by 0.75 equals 6.67%). This means an investor in the 25% tax bracket would need a taxable investment to pay at least 6.67% in order to receive an equivalent amount of income from another taxable investment.

Must I pay taxes on savings bonds?

Savings bond investments are taxable. You must pay federal income taxes—but not state or local taxes—on the income generated. If the savings bonds are part of an estate or inheritance, you must also pay inheritance taxes on it.

 
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