Investors should be aware that there are ways to legally reduce, defer, or even eliminate taxes on your investment gains, allowing you to keep more of your profits.
Your investment income is subject to taxation by the Internal Revenue Service (IRS), but it is treated differently from income derived from salary. These variations encompass not only the tax rates you pay, but also the timing and procedures for taxation of investment income.
Investments generate income through capital gains or cash income. These two income sources are taxed differently, as the IRS taxes capital gains only when they’ve been realized but they cash income for the tax year in which it was received.
How do you legally avoid taxes with investments?
You are only subject to taxation on realized capital gains, or when you sell an investment for cash, which is a key proviso to the IRS tax laws. This means that you have a legal gap to exploit there, as you won’t be subject to capital gains taxes, which can be considerable, as long as you don’t sell. You can actually hold onto your investments eternally and permanently postpone paying gains tax.
Meanwhile, employees can invest their money for retirement and receive some tax benefits by using an IRA. You can save money in a regular IRA pre-tax, which lowers your taxes for the current tax year.
Taxes on your earnings, including dividends and capital gains, might be postponed. You will be required to pay taxes on any money withdrawn from the account beyond the age of 59 and a half when it comes time to take distributions. This way you would be able to avoid paying taxes in your IRA for many years.
In general, you must pay taxes on dividends and other cash distributions in the year you receive them. So, unlike with capital gains, you don’t have an option to avoid paying taxes here if you’re utilizing a taxable account. However, if you hold your assets in different locations, you can reduce your dividend taxes.