A Taxing Investment

April 15 - The most dreaded day of the year is right around the corner. Are you ready? Some of the most neglected (and misunderstood) tax issues are those related to your investments. If you invest with taxes in mind, you can avoid a nasty surprise when Uncle Sam comes to collect.

The tax advisors are chiming in left and right on this issue. They say that you should limit yourself - and your investments - in order to minimize your tax burden for the immediate future. Those in the high tax brackets should go mainly for retirement accounts (as in tax deferred investments) and tax free investments, and those in the lower brackets should feel free to invest as they see fit. I'm sorry, but I don't necessarily agree with their synopsis.

Dividends, interest, and short term capital gains from your investments are all taxable at your standard income tax rate. Long term capital gains (that is - those coming from investments that you have held for over a year) are taxable at a lower rate. It would make sense then, for someone in a higher bracket (and thus paying a larger percentage of his or her dollar to the government) to focus primarily on limiting these types of income, and for those in lower brackets to go crazy with them, since they're not losing as much money.

Tax deferred retirement accounts, such as your IRA, 401k, or other retirement account, allow you to contribute a specific amount of money each year to your retirement. This amount is deductible from your income. That's not to say that these retirement accounts are tax free - far from it. These accounts are tax deferred, which means that you do pay taxes, though not until you take the money out. This offers the advantage of reinvesting your yields before taxes, which if done well can end up making you more money, but the fact remains that when you do access those accounts, the going tax rate may be less favorable than it is today.

Tax free investments do exist - to some extent. Municipal bonds and certain money market accounts can be tax free, however, you should always make sure that you deeply understand the taxing situation on these instruments before you actually put your money into them. In some, federal taxes or state taxes (or in some cases local income taxes) may be waived, but one doesn't imply the other, and the last thing you want is the surprise that you do owe taxes on a supposedly tax free investment.

If your portfolio has taken a little drive over the past year, you may find some solace in the fact that you can write off some of your losses. Up to $3,000 in fact. After three grand, you'll have to carry over your losses each year. This can result in a ton of paperwork, so make sure that the assessed tax difference will make up for the extra effort these filings would take.

Also make sure that you don't mix and match tax-beneficial instruments. You shouldn't put municipal bonds or tax free money market accounts in your IRA, for example. Since they're both tax free, you can end up losing out on the tax break the other provides. It's typically a better idea to use these instruments in conjunction with your regular assets. This is one of the points that I agree with the tax experts on. It just makes sense.

But I just don't agree with their investment strategy, as I mentioned before. It's all well and good to keep your taxes in mind when you're planning your investments out - and it's essential when planning for retirement - however, I just can't justify their methods. If you have had a good year financially, and find yourself in a higher tax bracket, chances are that you have a pretty nice retirement plan already. For someone making six figures, the ceiling on retirement contributions is just not enough money to be their primary focus of investment attention. If you know what you're doing, you will make money. I would much rather make money that taxed at 99% than not make a cent. It just doesn't make much sense to say that you wont invest outside your retirement account, just because you don't want it to be taxed.

Of course, if you're in a lower tax bracket, the experts recommend that you go ahead and invest in taxable securities, since your tax rate is less than, say, Bill Gates. I'm sorry, but this is ridiculous. It's pretty unnecessary for someone in a lower bracket to focus on taxable accounts alone. Actually, it's probably more important for you to pour money into your retirement accounts. With the battles going on in Washington over the "social security crisis" (which we'll touch upon next month), the best way to secure your future is to actively invest in it. If you're an active investor, splitting your investment allocated income fifty/fifty for your retirement and taxable investment accounts isn't out of line. If you don't invest very actively, and you don't think you'll need access to your retirement money, don't think twice about putting the majority of it in a tax deferred retirement account.

Essentially, my point is that your investment decisions shouldn't be held back in fear of your tax burden. If you can balance the two out, you might just find that it does make sense (and hopefully, you'll turn out more financially fit than you were before). A whole new tax year awaits, and we're ready for it.

Jonas Elmerraji is the founder and editor of growFolio, the world's first free online investment and business magazine. Issues are available online at http://www.growfolio.com

In The News:


pen paper and inkwell


cat break through


1031 Exchange Rules and Requirements

Following is a reproduction of the IRS's rules and requirements... Read More

Small Businesses: Company Car Vs. Personal Mileage Reimbursement In Hurricane Katrinas Wake

With gas prices at an all time high before Hurricane... Read More

Gambling Income and Expenses - Tax Requirements

Hit a big one? With more and more gambling establishments,... Read More

Tax Records - What You Should Keep And For How Long

Many taxpayers are confused about how long they should keep... Read More

Tax Deduction for Alimony Payments? - Yes!

Over 50% of marriages end in divorce in the United... Read More

Deducting Points On Home Refinances

Deduction of Refinance PointsAny points that you pay in the... Read More

Marriage or Divorce ? Check Your Social Security Number

Newlyweds and the recently divorced should make sure that names... Read More

How Home-Based Businesses Can Avoid Giving Uncle Sam More than His Share

How Home-Based Businesses Can Avoid Giving Uncle Sam... Read More

How To Set Up A Tax-Saving Bookkeeping System

One of the most important, but least understood or appreciated... Read More

Insider Guides to IRS Audits!

Ever wish that, as a business owner, you knew exactly... Read More

Rearrange Your Affairs For Maximum Tax Savings

One way to maximize your business profits is by reducing... Read More

Business Tax Deductions

As we enter mid-March, taxpayers begin to become very interested... Read More

Need an Offshore Sales Office in a Tax Free Environment?

The 100 year old investment-banking firm of... Read More

Access to E-records by Taxing Authorities: A Case for Pakistan (Part I)

Background issues of access to recordsTo assess the records at... Read More

How To Get An Extension To File Your Business Tax Returns

Yes, the tax season is upon with the first filing... Read More

The Implications of Income Tax Charge on Estate Planning

OverviewIn the Pre-Budget Report of December 2003 the Chancellor Gordon... Read More

Six Urban Myths About Taxation

Six Urban Myths ? Taxation"I am proud to be paying... Read More

IRS Reports Tax Gap of $300 Billion

The Internal Revenue Service is reporting that the difference between... Read More

Some Folks Pay A Lot Less Tax Than Others On Very Same Income?Did You Pay Too Much Tax In 2004?

Someone once remarked, "Next to being shot at and missed,... Read More

Early Distributions From Retirement Plans

An early distribution from an Individual Retirement Arrangement (IRA) or... Read More

10 Tax Tips to Reduce Costs and Increase Income

No one likes paying tax. Everyone understands that tax is... Read More

How To Claim CHILD TAX CREDIT The Right Way And Add An Extra $2,000 To Your Refund

The U.S. Department of Agriculture estimates that it costs nearly... Read More

Save Money on Taxes - Let Uncle Sam Pay for Your Fun!

"Deducting Meals and Entertainment"O.K. You've been working really hard on... Read More

Estate Taxes - It Pays to Plan Ahead

Estate taxes. It's not enough to simply know they exist,... Read More

How to Donate Your Car to Charity and Get Tax Deduction

Donating your used car to charity is a win-win situation;... Read More

Tax Trap #5 -- Ignoring The IRS (and the 5 best ways to contact them!)

We all love to criticize the IRS, don't we? And... Read More

What Is Tax Law?

The federal tax code is complex. This complexity generally arises... Read More

Highlights of IRS List of 2005 Tax Scams

Each year, the IRS lists various scams taxpayers get caught... Read More

Correspondence From The IRS ? Yikes!

It's a moment every person dreads. You pick up the... Read More

Home Based Business Tax Deductions

Running a home based business reaps many wonderful tax deductions... Read More

Understanding Marketing Tax Deductions

Marketing is a necessary expense in running practically any business... Read More

Small Business Tax Issues for Self-Employed Individuals

The United States is a nation of entrepreneurs. There are... Read More

Section 179 ? Tax Relief From Depreciation Rules

"Depreciation." For business owners, this word is the one most... Read More