Income Tax Issues in Personal Investments

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  • 0:00 What Are Income Taxes?
  • 0:54 Dividends and Interest
  • 2:16 Capital Gains and…
  • 3:29 Lesson Summary
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Lesson Transcript
Instructor: Tammy Galloway

Tammy teaches business courses at the post-secondary and secondary level and has a master's of business administration in finance.

In this lesson, we'll define income tax. You'll learn about three types of investments: stocks, bonds and real estate. We'll also discuss the various types of income received from these investments and their tax treatment.

What Are Income Taxes?

Sarah, a novice investor, filed her income taxes with the Internal Revenue Service and expected a refund. Income taxes represent a percentage levied against personal income. The Internal Revenue Service (IRS) manages the tax code and collects taxes for the federal government. Shortly after Sarah filed, the IRS sent her a notice stating her taxes were filed incorrectly and the revision resulted in a $1,500 liability rather than a $1,000 refund. Sarah was shocked and thought there must be a mistake. She visits a local tax preparation company and asks them to review her income tax documents. John, an income tax preparer, examines her income and notices all the money she made from investments were not calculated in the returns. Let's take a closer look at his analysis.

Dividends and Interest

Sarah invested in Corporation ABC's stock. Stock represents a percentage of ownership in a company. When companies need capital or money for growth, they issue stocks. There are two types of stock: common and preferred. Common stock investors are guaranteed voting rights, while preferred stock investors receive dividends regardless of the corporation's profitability. Dividends are monies paid on a quarterly or annual basis. At the end of the year, Corporation ABC mailed Sarah Form 1099-DIV, an annual total of dividends paid. Sarah did not file the amounts on her return.

Sarah also received interest from a bond investment that she did not report. A bond resembles an I.O.U. or loan, and represents an additional source of financing for corporations. In sum, Sarah purchased a $1,000 bond, and in return, received periodic interest payments. The company sent Sarah Form 1099-INT at the end of the year, which includes all the annual interest she received. Thus far, when John inputs the amount she received on the 1099-DIV and INT in the tax software, he sees that what Sarah owes the IRS is now up to $750. But John isn't done yet, as there is more unaccounted income to calculate.

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