What is a Taxable Event? Carmichael Hill

Put plainly: a taxable event is a transaction that causes someone to owe money to the government in the form of taxes.[1] Seems simple enough, right? When it comes to retirement and savings, there are a few important taxable events that you might want to keep an eye on.

Earned Income

Earned income is money you make from a job. This is reported on a form W-2 if you’re an employee or a form 1099 if you’re an independent contractor. It might also be reported on a schedule C or a K-1 if you’re self-employed or in a partnership. Regardless of how it’s presented to the IRS, you’ll owe money to the government when you receive earned income from an employer.

Don’t forget – you may also owe an additional tax on the income you make to your state depending on where you live, as well as amounts above that to your local government as well.[2] 

Dividends

Dividends are income that is paid to you from stocks that you own and businesses in which you are invested. Most dividends are taxable, though there are exceptions. This is especially important to keep an eye on if you are planning to use dividends as part of your retirement plan. Also, be sure to recognize that there are different types of dividends. Some of them are qualified, which are taxed at preferential long-term capital gains tax rates, while others are non-qualified, which are taxed at more onerous ordinary income rates.[3]

Crucially, dividends are only taxable to you if your Adjusted Gross Income (AGI, found on line 11 of your form 1040 on your tax return) is above $44,625 for single filers and $89,250 for married joint filers in 2023.[4]

Selling an asset

Selling any kind of capital asset for a profit is a taxable event.[5] Capital assets are things like cars, property, stocks, bonds, collectibles, and antiques. Just about everything you own, even mineral interests, royalties, and patents, are capital assets.[6] Sales of these assets triggers capital gains tax when a profit is made. Long-term capital gains are recognized when you’ve held the asset for at least a year. Short-term gains are recognized when you’ve held it less than a year. [7]

The distinction is key; long-term rates are quite favorable at either 0%, 15%, or 20% depending on your adjusted gross income. But short-term gains are taxed at the more onerous ordinary income rates. These are the same rates that apply to earned income and can be as high as 37% in 2023. From a tax perspective, recognizing a $10,000 short term gain is no different than receiving a $10,000 bonus.

There are many reasons to dispose of an asset and it’s important not to let the tax tail wag the dog. But as a general rule, you’ll want to avoid short-term gains and recognize long-term gains where possible due to the preferential tax rates.

Net Investment Income Tax (NIIT)

If you earn enough income, either $200,000 as a single filer or $250,000 as a married joint filer, then an additional 3.8% tax applies to the investment income you earn from your portfolio. This includes all dividends, interest, and net short or long-term capital gains earned in your portfolio.

Rental properties

Money earned from rental properties, just like most all other income, is also taxable. This type of income is reported on a Schedule E. Real estate benefits from many tax advantages, and the depreciation expense you are able to claim on rental real estate is often able to significantly reduce the amount of income recognized on your Schedule E. But, to the extent that you do recognize income it is typically taxed at ordinary income rates.

Social Security, Pensions, and Retirement Accounts

Social Security is a unique animal. It is never fully taxable to you. Depending on your income, either none of it, half of it, or 85% of will be taxable. This income is subject to ordinary income rates, but the fact that some of it is always non-taxable is a unique benefit to you.

Pensions may look and feel indistinguishable from Social Security, but they don’t get the same kind of tax break. The money that you contributed to these accounts, or the money that your employer set aside for you in these accounts, was never taxed. This means that 100% of it is taxable to you upon withdrawal and it is taxed at ordinary income rates.

Pre-tax retirement accounts, such as IRAs and 401(k)s are treated the same as pensions for tax purposes. With limited exceptions, all dollars distributed are subject to ordinary income taxes. What’s important to remember with these accounts is that it is the distribution that triggers taxes. Trading does nothing so long as money stays in the account. This stands in stark contrast to a taxable investment account, in which distributions of cash do not trigger any tax but trading does! The distinctions are important to keep in mind as you trade, rebalance, and distribute from your various accounts.

The Takeaway

Taxes and tax management are an important part of wealth management, and failing to property account for them can lead to headaches and mistakes. Whether you’re looking for a few helpful pointers or a more in-depth tax optimization strategy as you near retirement, give us a call. We can set up a complimentary consultation to help you minimize taxes and keep more of what you earn.

 

REGULATORY DISCLOSURE

Carmichael Hill & Associates, Inc. is a U.S. Securities and Exchange Commission Registered Investment Advisory firm. Registration does not imply that the SEC has endorsed or approved the qualifications of Carmichael Hill or its respective representatives to provide any advisory services. Advisor does not render or offer to render personalized investment advice or financial planning advice through this medium. Advice can only be given after:

  1. Delivery of a disclosure statement by advisor to client.
  2. Execution of our Investment Advisory Agreement between the client and the advisor.
  3. Initial payment of the planning fee or investment advisory fee by the client to the advisor.
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DISCLAIMERS

The information in this web site is based on data gathered from what the Advisor believes are reliable sources. It is not guaranteed as to accuracy, and does not purport to be complete and is not intended as the primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. The identification of specific funds and model portfolios is being made on the assumption that the investor would participate in that investment or portfolio on a long-term basis and only after consulting with their investment advisor to determine their needs and tolerance for risk. With respect to any such identification, there can be no assurance that the fund or model portfolio will in fact perform in the manner suggested.

The results do not represent actual trading due to the timing of the clients’ trades and their trading costs. They may also not reflect the impact that material economic and market factors might have had on the advisor’s decision making if the advisor were managing the clients’ money. Investment and portfolio results may be different than the results the advisor’s discretionary clients achieve due to the timing of trades and the market conditions.

All references that might be made to an investment or portfolio’s performance are based on historical data and one should not assume that this performance will continue in the future.

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