How are Investments Taxed?
How Are Investments Taxed?
By David Ruedi, CFP®, RICP®
'The tax treatment of an investment depends on four things: the type of investment account, the form of investment return, how long a person has held an investment, and a person's total taxable income for the year.
In retirement accounts, the tax treatment depends on whether you make "Traditional" or "Roth" contributions. In "Traditional" retirement accounts, you put money in pre-tax. When you take withdrawals, the entire withdrawal is taxed at your ordinary income rate.
In "Roth" retirement accounts, you put money in after-tax, and the money grows tax-free from that point forward. You won't owe taxes when you take withdrawals from Roth accounts as long as they're qualified withdrawals.
In a taxable brokerage account, you will typically owe taxes each year on the interest, dividends, and realized capital gains in the account. Interest is paid out from bonds when you loan your money to companies and governments. This income is taxable at your ordinary income tax rate in the year it is paid. The most notable exception to this is interest from municipal bonds, which is exempt from federal taxes, however it is still taxable on your State of Illinois tax return.
Dividends are paid by companies who want to distribute a portion of their earnings to their stock owners. The tax treatment of dividends depends if they are "ordinary" or "qualified." Ordinary dividends are taxed at your ordinary income tax rate. If the company and investors meet certain requirements, they may distribute "qualified dividends" which are taxed at more favorable tax rates.
Capital gains occur when an investment is sold for a gain. Gains on investments sold after being owned for less than one year, called "short-term capital gains," are taxed at your ordinary income tax rate. Gains on investments sold after being held for longer than one year, called "long-term capital gains," are taxed at more favorable rates.
For the 2025 tax year, if your taxable income was less than $48,350 ($96,700 for couples filing jointly), you do not owe any taxes on qualified dividends or long-term capital gains. If you had between $48,350 ($96,700 for couples) and $533,400 ($600,050 for couples) of taxable income, then you will pay a tax rate of 15% on qualified dividends or long-term capital gains. People above those limits pay a tax rate of 20% on qualified dividends and long-term capital gains.
In addition to capital gains taxes, some taxpayers with modified adjusted gross income (MAGI) above $200,000 for single filers ($250,000 for couples) will also have their capital gains, interest, and dividends subject to a 3.8% Net Investment Income Tax (NIIT).
David Ruedi is a Certified Financial Planner™ Professional at Ruedi Wealth Management in Champaign, Illinois.