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Taxes on taxable accounts
Old 07-27-2009, 04:21 PM   #1
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Taxes on taxable accounts

I've never looked into taxable accounts and am wondering how and when the money is taxed. Is it sort of like a money market account but with capital gains taxes?

So the money going in is taxed, the amount earned each year is added to your AGI, and when you withdraw the money you owe capital gains tax?
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Old 07-27-2009, 05:03 PM   #2
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I am sure others will weigh in with more concise info but here is my simplistic view. If you buy and hold for more than a year then sell, it is considered long term capital gains. If you buy and sell (active trades) the taxes due are the same as income and you need to do quarterly estimated payments. Dividends are taxed as long term and as long as you have sufficient withholding to cover your tax due to the IRS it is ok. In these times make sure not to under-report.
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Old 07-27-2009, 06:00 PM   #3
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One thing to be very aware of starting out is that if you hold actively managed mutual funds in a taxable account, when the fund managers sell holdings during the year that realize capital gains, they will be distributed to you proportionally to the number of shares you hold. You will owe capital gains taxes on your share of the distributed gains, in addition to taxes on any proportional dividend income, whether you have those distributions automatically reinvested or otherwise personally realize them (e.g. have them sent to money market or whatever). With active funds, you can even have capital gains taxes due in years in which the fund's NAV has decreased, adding insult to injury, so to speak. As others have clarified below, these distributions are added to your cost basis going forward, but paying taxes on them along the way still can be a drag. Index funds tend to generate minimal, if any, capital gains from internal trading activity, and therefore you can have much more control over when you realize any capital gains (i.e. only when you actually sell shares for a gain).
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Old 07-27-2009, 06:19 PM   #4
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So say someone invests $10,000 in an indexed mutual fund in a taxable account and it grows $1,000 a year for 10 years. If the person is in the 25% tax bracket they would owe an additional $250/year on their taxes? If they withdrawal the money after 10 years they'll owe an additional ($10,000 x 15% - or whatever the capital gains tax is). So the effective tax rate is 40%?

I'm guessing there's more to it than that but am I along the right track?
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Old 07-27-2009, 06:34 PM   #5
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No, you aren't taxed twice on the gains.

There may be capital gains and dividends incurred in a year depending on what trading the fund manager does. Some may be long term, some may be short term. These aren't necessarily related to the gain in value of your mutual fund. Any gains are added to the basis of your stock.

Then when you sell, you owe tax on the difference between what you get and (what you paid for it + capital gains and dividends through the years).
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Old 07-27-2009, 06:35 PM   #6
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No and Yes. The following assumes an equity growth index fund with no dividend distributions.

No: if the fund increases in value but doesn't declare a capital gains distribution, you owe nothing next year.

Yes: if the fund declares a capital gain distribution, you would owe 15% next year on the value of the distribution. At the end of the 10 years, if you sold the entire appreciated amount, you would owe capital gains taxes at 15% of the value gained, not 40%.

So, after two years you sell 25% of the fund. In the interim, the fund has grown to $12,000 and you sell $3000 worth. You owe 15% capital gain on the difference between what you originally paid ($2500 for 25% of the $10,000 investment) and what you sold it for ($3000). So $500 *.15 ($75) is the tax you owe.

If you held the fund for 10 years, and it was valued at 20,000 at the end of 10 years and you sold the entire thing, you would owe taxes on $10,000 @.15, or $1500.

It's a 15% effective tax rate, whether you sell part, all, or if the fund distributes capital gains.

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Old 07-27-2009, 06:37 PM   #7
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start here:Basic Questions About Capital Gains and Losses

then here:

for mutual funds:
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Old 07-27-2009, 09:11 PM   #8
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You only pay taxes on net realized gains. If you have a loss, then you get tax deduction.
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