What You Need To Know About Taxes and Investing

What You Need To Know About Taxes and Investing

Taxes play an important role in your financial life. Their reach extends far beyond the dreaded April 15 (now July 15th for 2020) date and come into play much more than once per year. Taxes are actually involved in nearly every financial decision you make, chief among them being investing

Taxes are to investing as textbooks are to education—you can’t have one without the other. So how do taxes work when you are investing and in what ways can they impact and inform your investment strategy?

Let’s find out!

What Accounts are Taxable?

Before we dive into the type of taxes to look out for, let’s review what type of accounts generate taxes. 

Investment Accounts and Taxes

A taxable investment account, otherwise known as a brokerage account, is an account that is funded by after-tax dollars and allows the account owner to invest in nearly any type of security. Those securities could be

  • Stocks
  • Bonds
  • Mutual Funds
  • Real estate
  • ETFs

With taxable investment accounts, you will be required to pay taxes on any gain in the year that gain happened. So if you had a capital gain of $5,000 in 2020, that money will need to be claimed on your 2020 tax return. 

But what happens if your investments lose money? If you sell an asset at a loss (less than what you paid for it) that is known as a capital loss and doesn’t require any taxes. You can work to balance your tax bill by strategically balancing your capital gains and capital losses in a year as these losses can be used to reduce your taxable gains. In addition, you can deduct up to $3,000 in capital losses each year on your tax return with an option to carry forward the remainder. 

Retirement Accounts

Your long savings journey to retirement won’t come without its fair share of tax responsibilities. There are a couple of accounts that are tax-deferred accounts, which means the accounts contribute and accrue gains tax-free until distribution in retirement. The top two tax-deferred accounts are 401(k) and a Traditional IRA. 

Both of these accounts are funded with pre-tax dollars. All of the gains continue to grow tax-free and are only subject to tax when you take distributions in retirement as ordinary income. 

A Roth IRA and Roth 401(k), on the other hand, requires you to pay taxes when you contribute the money but not when you take it out, making it a vital savings vehicle for retirement. Roth IRAs do have income thresholds so if you make over $139,000 for single filers or $206,000 for married filers your options are limited, but you may be able to still contribute to a Roth by initiating a Roth transfer or backdoor Roth IRA in which you transfer funds from a traditional IRA into a Roth. 

What Taxes Will You Owe (And Why)?

If you are earning money on an investment, the IRS will want a portion of that gain. Below are three main types of tax you might deal with when investing. 

Capital Gains Tax

Capital gains tax is triggered when you make money, or realize a gain, on an investment. This comes from the sale of an investment at a higher price than what you paid. Sounds simple right? Well, the IRS has come up with a couple of stipulations to determine the percentage of capital gains tax that you will owe.

  • Household income
  • Length of time you held the investment

These two factors work to determine the percentage of tax you will pay on a capital gain. The first factor is based on your household income and your ordinary tax bracket and this number really informs the second criteria of how long you held the investment. 

If you retain an asset for less than a year, that is considered a short-term capital gain and will be taxed at a higher rate, anywhere 10%-39.6% depending on your tax bracket. But, by holding onto your investments for a year or more, you will be eligible for the more favorable long-term capital gains rate, which ranges from 0%-20%, though most people pay about 15%. Again, that percentage will depend on your tax bracket. 

Since selling assets costs you money, why is it worth doing? There are many reasons for people to sell assets including

  • Withdrawing money
  • Rebalancing a portfolio
  • Desire to make a change to investment strategy 
  • Changing risk tolerance 
  • Diversification needs
  • Market performance

The bottom line here is that your investments aren’t stagnant. They are moving and changing as your needs change. It is important to keep up with your investment strategy and understand what your needs and goals from it are to better create a plan that works for you. 

Ordinary Income Tax

The second type of tax that you will need to factor into your investments is the ordinary income tax. This tax comes into play when you earn income through your portfolio in the case of dividends and interest payments.

Dividends are an interesting category and another way for you to experience tax on your investments. Some investments pay quarterly or annual dividends to their individual investors which are basically just a check that goes into your account. Interest works in a similar way. As a shareholder, some investments will pay you regularly, resulting in income. 

This income is taxed at your ordinary-income rate. There are, of course, exceptions to this rule. Interest from municipal bonds is exempt from federal tax and for those lucky to live in California, they are exempt from state tax as well. If a dividend meets certain IRS regulations, it can be a qualified dividend that is taxed at the capital gains rate. 

How to Keep Taxes in Mind When Investing

Tax planning is an important step to get the most out of your investments. As you can see, they play a major role in your overall profits. When factoring in taxes into your investment plan there are a couple of strategies to keep in mind. 

  • Asset allocation
  • Asset location

Asset allocation is a strategy that looks at the specific securities that you invest in, like stocks and bonds, as well as the balance between those securities. Based on your aggressive risk tolerance, one account might be allocated to have 80% stock and 20% bonds, as an example. 

If asset allocation is the balancing of securities, asset location takes it a step further by determining the best place to house those securities in order to make them as tax-efficient as possible. Believe it or not, where your securities live makes a huge difference in your overall return. Creating a strong plan around the role taxes play in your investments can help you come up with a strong, balanced, comprehensive investment plan. 

Your investment goals will change and evolve as you do, so don’t be afraid to make changes when you need to. A situation might happen when you want to rebalance your portfolio or the market fluctuations support a different allocation depending on your risk tolerance and investment horizon. 

The most important thing is to remember the investment goals that you set and employ a level of flexibility so that your strategy stays in line with where you are at in your life now. 

 Ready to change the way you approach your finances? Schedule a time to talk with us

Episode 103: Bookkeeping Strategies and Business with Greg Higdon

Episode 103: Bookkeeping Strategies and Business with Greg Higdon

Episode 103: Bookkeeping Strategies and Business with Greg Higdon

This week I sat down with bookkeeper, Greg Higdon to discuss the importance of having a bookkeeper and what working with one can do for your business.

Greg Higdon is the Founder of Grow the Books, a bookkeeping company for small businesses. With over 13 years of experience in education, he teaches his clients so they are empowered and armed with a clearer understanding of what their numbers mean for their business decisions. When he isn’t balancing books and helping clients you can find him roasting coffee, drinking coffee, and reading about coffee.


  • The importance of understanding your profit and loss statement
  • What a bookkeeper can do for you
  • The difference between gross and net income
  • How bookkeeping plays a part in your taxes
  • The tax challenges you’ll face if you don’t keep up with your books
  • Bookkeeping issues Greg tends to see when they come to him for help
  • Some of the terms on your income statement and what they mean for your business
  • The benefits of giving your business income and expenses subcategories
  • How to know how much your business should be spending in marketing, personnel, sales, etc.
  • How often you should be reviewing your profit and loss reports
  • Comparing hiring out versus doing your own books
  • What to look for when hiring a bookkeeper
  • If you want to do your books on your own, do this to make things easier on you




Episode 58: Analyze Your Paycheck Like a Financial Planner

Episode 58: Analyze Your Paycheck Like a Financial Planner

Employee Benefits
Employee Benefits
Episode 58: Analyze Your Paycheck Like a Financial Planner


One of the fun parts of being a financial planner is getting to field and answer questions from clients and readers all around the country. In these Work Your Wealth episodes I’ll be taking time to address and answer questions I’ve come across from readers and clients throughout my career. Today I’m answering the above question.


  • What I see when looking at your pay stub and how I use it to leverage and understand what’s happening with your money.
  • What to look at first when analyzing your paycheck to avoid confusion.
  • The difference between your gross pay and your net pay.
  • The importance of knowing if you’re paid monthly, biweekly or twice a month and how it impacts your budgeting.
  • What exemptions are on your pay stub and how it saves you taxes.
  • How your withholdings impact your paycheck and your annual tax refund (or amount owed).
  • What to aim for when electing your withholdings.
  • How (and when) to adjust your W-4.
  • The importance of knowing what state and local taxes are being withheld.
  • Who FICA is and why they take so much of your money.
  • What you pay in taxes as a sole proprietor and the impact on your cash flow.
  • Where to find employee benefits that you may be missing out on.
  • How to determine what you’re contributing to your employer sponsored retirement plan.
  • The tax advantages of a Flexible Spending or Health Savings Account.
  • Other employee benefits that can help you improve your financial situation.
  • Which deductions you can and can’t change.




Episode 45: Tax Planning Hacks and Getting On Track with John McCarthy

Episode 45: Tax Planning Hacks and Getting On Track with John McCarthy

Episode 45: Tax Planning Hacks and Getting On Track with John McCarthy

This week I sat down with CPA and Tax Professional, John McCarthy.

John is a CPA and founder of McCarthy Tax Preparation and Advisor Facing Tax where he has helped families and small businesses with income taxes and planning for the past 15+ years. He is also a past member of XY Planning Network, a leading organization of fee-only financial advisors who specialize in helping members of Gen X and Gen Y. John graduated from Purdue University with a Bachelors in Science in Accounting. John left his salaried corporate tax job to provide tax preparation and planning services to financial advisors and their clients as a full time entrepreneur.


  • Why you’re not alone if you’re afraid of your taxes
  • How to know if the IRS is actually trying to contact you versus being stuck in a scam
  • Errors you should be looking out for in your personal tax situation
  • Why it’s important to work with a tax professional each year (no matter your situation)
  • How to determine if you are withholding the proper amount for taxes
  • Whether you should aim to have a large refund versus owe at the end of the year
  • How to be best prepared when working with a CPA to get your taxes done
  • What questions to ask a CPA, a Financial Planner and a Bookkeeper
  • Why it’s important to talk to a tax professional during life transitions
  • Areas people tend to make mistakes when it comes to taxes
  • What happens if you owe on your tax return but don’t have the funds on hand to pay
  • The best way to get current with your taxes through the quarterly installments
  • How business owners can stay on top of their taxes
  • Standard versus Itemized deductions




Money Moves to Make (and Questions to Answer) Before Taking Your Side Hustle Full-Time

Money Moves to Make (and Questions to Answer) Before Taking Your Side Hustle Full-Time

You’ve been working on your side hustle for a while now to generate some extra money on the side. It’s always been something fun and enjoyable — and you’ve gotten really good at it.

So good, in fact, for the last 3 months you’ve made more than you make at your day job! And you’re ready to devote yourself to this budding business full-time. Can you make the transition?

First, look back at your side hustle income. How long have you been at it, and how much have you made total? Are you making enough to pay taxes, business expenses, yourself (via retirement savings and investments), bills and living expenses, and have a little left over for discretionary spending or to reinvest in your business?

Were those last 3 months sustainable or was there a reason for a big bump in earnings? Is your income seasonal, meaning you need to plan for slow times by saving more of your income when you’re busy and making more?

These are the kinds of financial questions you need to ask yourself before you hand in your notice at work to leap into a life of self-employment.

There’s not necessarily a right and wrong answer here — but it’s important to think through these things and gather the information and details so you can make the best decision for you when determining if it’s time to go from side hustler to full-time entrepreneur or freelancer.

Here are some other questions to consider and the money moves you need to make before you make a change.

How and When Will You Pay Yourself?

It’s nice to generate an income on your own and be in control of your own salary. But that also requires discipline. Just because you made an extra $2,000 this month doesn’t mean you should transfer it to your personal checking account and enjoy a little shopping spree.

Decide how much you’ll pay yourself each month and stick to it. You can pay yourself weekly, twice a month, or once a month. Anything extra is profit in your business and can go toward investing in your work, savings, or retirement accounts.

Who’s Taking Care of Your Future?

Speaking of, when you go from side hustler with a day job to full-time entrepreneur, you don’t just lose your steady paycheck. You give up access to employer-sponsored retirement accounts too.

That doesn’t mean you’re out of luck when it comes to saving for your future. It just means you’re responsible for funding your retirement accounts on your own. Make sure you set aside a percentage of your earnings to contribute to an appropriate savings vehicle, like a traditional, Roth, or SEP IRA or a Solo 401(k).

Do You Know How to Budget on Variable Income?

Most people who freelance or own their own business don’t make the exact same amount month after month. Not only does your income rise and fall each month, but your expenses might too.

Before you strike out on your own, make sure you can budget on a variable income.

That means knowing the difference between your truly necessary, non-negotiable expenses (like your rent or mortgage, utilities, and groceries) and expenses that you usually pay every month and make your life a little better, but aren’t essential to your wellbeing and survival (everything else).

You also need to be prepared to cut back on anything that’s a want or a discretionary purchase if you experience a month where you make less than usual.

Do You Have an Emergency Fund?

Regardless of the type of work you do, you need a cash reserve set aside to help cover emergencies and unexpected expenses. The general rule of thumb says to put 3 to 6 months’ worth of expenses into an account you can easily access should you need cash immediately.

But when you want to go from side hustle to full-time self-employment, you take on more risk because you leave a steady paycheck behind. That can make your cash flow more volatile, increasing your chance of getting stuck with a hefty bill in a slow period where you made less than expected.

Before you go out on your own, make sure you have at least 6 months’ worth of expenses stashed away in your emergency fund. You may also want to build a cash cushion in your business checking account, since you may experience not just personal emergencies but professional ones, too.

Do You Want to Buy a House in the Next Few Years?

Plenty of people take a side hustle full-time because it’s more lucrative than their day job. They have big goals to hit, like buying a house. But unfortunately, going into full-time self-employment in order to do something like that can backfire.

That’s because mortgage lenders require 2 years’ worth of tax returns as proof of your self-employment income in most cases. Even if you have more in the bank thanks to your side hustle turned full-time business, you may not get approved for a loan until you have those tax returns showing your official self-employment income.

Think through your goals and consider how switching from employment to self-employment may impact your ability to reach them — whether it’s through a technical issue like needing to build a history of tax returns showing self-employment income or through practical ones like the possibility of a cash flow that fluctuates from month to month.

Are You Prepared to Pay Taxes?

Taxes get more complicated when you work for yourself full-time and no longer make any kind of W2 income.

You may need to pay more than you did when you were an employee making 1099-MISC income on the side. And depending on your situation, changing your filing status (from a sole proprietor to an S-corp, for example) may make sense.

Before you head off on your own, make sure you have a good CPA lined up who can help educate you about your business taxes.

What’s Next for Your Financial Plan?

On a similar note, plan to speak with a fee-only financial advisor who understands the ins and outs of self-employment before you make the leap.

Changing up your career path can lead to changes in your financial situation. Talking through the possibilities now will help you leverage your resources and capitalize on any opportunities that might come your way.

It’s all about being proactive to put yourself in the best position possible to enjoy success — both in your new full-time venture and your financial life.