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For stock market investments, total returns include realized capital gains and dividends, minus sales commissions, and taxes. Intelligent investors recognize tax planning as a major component of the wealth creation process.

Tax law is constantly in flux, and at the whims of the political establishment. Much of today’s tax code does trace its origins back to the Economic Growth and Tax Reconciliation Act of 2001 and Jobs and Growth Tax Relief Reconciliation Act of 2003 – colloquially known as the Bush tax cuts.

Onyx Investments will structure accounts and trading activity in a tax efficient manner to deliver real value for clientele, as part of our complete mission.

Dividend Income

Corporate dividends are subject to double taxation. First, corporations pay dividends out of after-tax profits. For 2023, the U.S. corporate tax rate is 21 percent. Additionally, state levies range from 2.5% in North Carolina to 11.5% in New Jersey.

Next, shareholders include these dividends received as taxable income. For taxation purposes, dividends are classified as either qualified or ordinary. A stock must be held for more than 60 out of the 121 days surrounding the ex-dividend date, for its dividend payouts to qualify for special tax treatment.

Qualified dividends and long-term realized capital gains are both taxed at zero, 15%, and 20% rates. Single filers reporting taxable income between $41,675 and $459,750 ($83,350 to $517,200 for married filing jointly) will pay a 15% tax on qualified dividends.

Ordinary dividends will be taxed as ordinary income. For 2023-2024, seven tax brackets levy income at 10%, 12%, 22%, 24%, 32%, 35%, and 37% rates.

Single filers reporting at least $578,126 ($693,751 married filing jointly) in taxable income take up the highest bracket.

Realized Capital Gains and Losses

Pay taxes on realized capital gains for the tax year in which they occur. Capital gains and losses are realized at the exact moment that you sell stock. For tax purposes, the IRS classifies capital gains and losses according to time frame.

Again, like qualified dividends, long-term capital gains receive favorable tax treatment and are taxed at zero, 15%, and 20% rates. Short-term capital gains are taxed as ordinary income, with the highest bracket being taxed at 37%. Long-term investments are held for at least one year, before being sold.

Net realized capital gains are added to your taxable income. Subtract long-term capital losses away from long-term capital gains and take short-term capital losses away from short-term capital gains to calculate net realized capital gains.

In prior years, we would also regularly add brokerage commissions back to cost basis and subtract these costs away from realized capital gains. Now, commission-free trading is a brokerage industry standard.

Realized capital losses over and above total capital gains will be written off from taxable income to the maximum amount of $3,000. Any realized capital losses exceeding the $3,000 cap will be carried forward as tax deductions for future years.

The IRS prohibits capital loss deductions on wash sales. A wash sale occurs when you sell off stock at a loss, and immediately buy that same stock back within 30 days. The 1099-B form will identify wash sales and omit these transactions out of cost basis and realized capital loss calculations.

Organize, Prepare, and File Tax Paperwork

Brokerages will prepare and deliver Form 1099-B, Proceeds from Broker and Barter Transactions, and Form 1099-DIV, Dividends and Distributions, prior to the start of each tax season. These two forms detail dividend income and capital gains and losses from all investments made through the brokerage.

On Schedule B, you will itemize all ordinary dividends according to the payer and amount. From here, you will add total qualified and ordinary dividends onto the Form 1040 income tax return.

Reconcile Form 1099-B and brokerage statement data to calculate total capital gains and losses by subtracting away cost basis from gross proceeds. 1099-B information is then entered directly onto IRS Form 8949, which lists out individual securities according to long and short-term trading activity.

From here, Schedule D summarizes Form 1099-B and 8949 information, by netting out long and short-term capital gains, or any realized capital losses. Schedule D, again, warns that realized capital losses cap out at $3,000 for the tax year.

Schedule D capital gains (or losses) appear as a Form 1040 income line item. Lastly, we reference the Qualified Dividends and Capital Gains Tax worksheet to calculate the final tax bill.

Retirement Accounts

All retirement accounts allow for tax-deferral, which means that you will not owe taxes on dividends and capital gains, as they occur within the account. In most cases, retirement accounts will trigger a 10% additional tax penalty on early withdrawals made before age 59 ½.

Roth IRA contributions are made with after-tax money, which does allow for complete tax-free withdrawals at the age of 59 ½. Roth IRAs are especially ideal for young professionals, who expect to retire at higher tax brackets.

Traditional IRA, 403(b), and 401(k) accounts mirror the Roth IRA. Traditional IRA, 403(b), and 401(k) retirement account contributions are tax deductible. As such, all future distributions are treated as ordinary income and taxed accordingly.

Investment Strategy

Our ultimate goal remains to generate alpha returns for the least amount of financial risk. Making money on stocks does not always translate into a minimal tax bill.

Retail clients are likely to find 401(k) plans at work to be highly limited. Ed from Accounting would have already retired as a multi-millionaire, had he have bought Apple stock through a taxable account, instead of maxing out his 401(k) only to dump cash into a money market mutual fund.

Onyx Investments prefers to pay capital gains taxes on a spectacular investment, rather than to smugly pat ourselves on the back for writing off a bad trade.