Extending Chapter 12: Planning Your Tax Strategy

What You'll Do and Learn

• You'll learn how income taxes can affect your investment choices and the returns your investments provide after taxes.
• You'll calculate the after-tax rate of return on different types of investments.

Introduction

In this activity you will apply your understanding of personal income taxes and learn how your income tax rate can affect your investment choices.

Chapter Notes

Chapter 12 provided an overview of how taxes affect your financial situation and different types of taxes that may apply to you. You learned that your investment earnings are subject to taxes and that certain types of investments can increase your taxable income.

Interest and dividend income is taxed as ordinary income, which means they are taxed at the same tax rates that apply to your wages. In addition to taxable income, investments may also provide taxable capital gains. A capital gain is the increase in the value of an investment. A capital loss results when your investment's value is less than what you paid for it. Capital gains are classified as either short-term or long-term depending on how long you owned the investment. If you sell an investment within one year of the purchase date, your capital gain or loss is considered short-term. Capital gains and losses on investments held for more than one year are considered long-term.

Short-term capital gains are taxed at your ordinary income tax rate, while the tax rate on long-term capital gains is capped at 10 percent for those in the lowest income tax bracket and at 20 percent for taxpayers with higher incomes. This difference in the tax treatment of investment income and short-term capital gains compared to long-term capital gains is an important factor to consider in choosing investments. If you are investing for long-term goals that are more than five years away, you may want to choose investments that provide most of their returns in capital appreciation rather than income, such as stocks.

Site Notes

Standard & Poor's offers a calculator that can help you estimate how taxes can affect your investment returns. The Expected After-Tax Return calculator calculates the after-tax rate of return for stock, bond, and money-market investments based on historical information for each type of investment.

Let Me Try

Go to the S&P site and then print the Worksheet activity.

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