What you should know about paying taxes on your investments

Many of us can remember receiving our first official paychecks. In our heads we have calculated the number of hours that we worked by our minimum wage pay and have already spent the money that we know is coming to us. To our great disappointment the government got to our checks before we did and taxes has swallowed up what was to us a huge percentage of what we had worked so hard to earn. The big bad tax monster is just as scary now as it was then, but now we are making more than minimum wage. We are making money that we are or will be taxed on years down the road when we tap into our retirement and investment accounts.

Taxes are a fact of life. We cannot avoid them without staying out of prison, so it is best to learn how to ease the sting of giving away our hard earned money. The first step to knowing about how taxes affect your investments is to realize (come out from your state of denial) that you will have to pay taxes on every investment dollar that you earn. The money that you earn from investments from stocks is called capital gain.

For every dollar that you earn from capital gains you have to pay the applicable tax rate. The only way to catch a break on this rule is to make sure that you hold on to your stock for at least a year. After a year you can qualify for a reduced capital gains tax. Even though you still have to pay, at least you won't have to pay as much. If you really did well with investments that year your reduction can add up.

Capital gains tax takes both your losses and your gains into account and there are specific rules that apply for calculating total gains and losses with a single issued stock. The amount of capital gains taxes will depend on your overall income from your investments.

There may be instances when the company that has issued the stock will absorb some of the tax responsibility prior to issuing dividends. Much like receiving a paycheck, you can have your tax obligations deducted before receiving you gains. You can also choose to place your investment earnings in an individual savings account. This tax-efficient vehicle allows for interest to be accruing on income so that when the time comes for tax payment, you have a little bit of help from the interest that was paid to your capital gains holding account.

In many cases you can choose when you pay your taxes on your investments. The common options are to pay taxes on investment income as it is accrued or to pay taxes as funds are withdrawn from the investments account. Paying tax as money is received rather than waiting until you make withdrawals is the best option for people who end up in a higher tax bracket when they retire. Most would hope to be in a higher tax bracket after years of work, higher tax rates, cut budget deficits, etc. and therefore would benefit most from paying taxes on money as it is earned.

Yet many people would rather postpone what could be done today. Tomorrow is always a better option when it comes to giving our money away. Even through programs are currently being offered that promote tax-deductible individual retirement accounts and 401(k)'s so that you will not have to pay a higher rate on a larger accumulation of your investment, people postpone the inevitable. Tax advisors and financial planers agree that a better plan for paying tax on investments is to just pay the tax now, and enjoy tax-free income and assets later.