Skip to main content

After Tax Investments: Dividend Income > Tax Advantages



After tax investments should be a big part of your retirement plan as I previously posted.  Not only can you reduce your taxes, your after tax investments can also be accessed now without paying an early withdrawal penalty tax to the IRS. So they are a great of source of funds to pull from in the event of an unexpected emergency or investment opportunity.  But what about the tax on the profits?  That is a great question.  In fact, I received this tweet as I was writing this post:

In most cases your profits from your after-tax accounts will either be classified as dividends or capital gains. Here is how the IRS defines dividends:

Dividends are distributions of property a corporation pays you because you own stock in that corporation. 
If you read between the lines you will notice, that dividends are really your share of the profits that have already been taxed once by the IRS (technically Uncle Sam but that is splitting hairs). Distributions that are a return on your invested money are taxed as capital gains to the extent the distribution exceeds your basis.  So now that the entity is distributing already taxed profits to the shareholders these distributions are call dividends.

Ordinary or Qualified Dividends:

The dividends you receive will be classified as either "ordinary" or "qualified."  This is very important from a tax standpoint, because "ordinary" dividends are taxed as ordinary income at your ordinary income tax rate.  But "qualified" dividends that meet certain requirements can be taxed at the favorable capital gains rates.

For more information about qualified dividends see IRS publication 550.

Long Term Capital Gains Rate:
Long Term Capital Gains Tax Rates are determined by the individual's personal income tax bracket.  Below are the 2014 Long Term Capital Gains Tax Rates as they correspond to personal income tax rates.

Personal Income
Long Term
Tax BracketCapital Gains Rate
10% - 15%0%
25%-35%15%
39.6%20%
While taxes on ordinary income can range from 10% to 39.6% your capital gains rates can be much lower or even 0%.  So while your post tax investments have already been taxed, the profits on them will typically be taxed but at much lower or favorable capital gains rates.  So the taxes you pay on the profits from your investments in your after tax (investment) accounts can be taxed at much lower rates than the funds in your retirement accounts will be taxed at.

Now make sure you get this point, the tax on distributions (not just profits but all distributions) from retirement accounts are at the higher ordinary income tax rates and not the favorable capital gains rates.  So even though the profits made in your retirement accounts may be the same as capital gains they are taxed at ordinary income tax rates because you never paid tax on the money invested into the retirement account.  So of all your money taken out of retirement accounts is typically taxed at the higher ordinary income tax rates.

So once again, you can see your investment accounts (after-tax dollars) should be a powerful tool in your plan for retirement.  While your funds in retirement accounts will be taxable as ordinary income when you take them out, your post or after-tax investments have already been taxed so when you take those funds out they are technically tax-free at that point while the profit can be taxable but often at favorable capital gains rates.  So in retirement it would be nice to pull from retirement accounts up to your standard or itemized deduction and exemptions so that you do not pay tax on them. After that you can pull from post tax investments and only pay tax on the untaxed portion of the profits. In theory then you could have a tax free retirement, at least at the federal level based on today's tax laws.

For more information about retirement planning see my post: How to Avoid Income Taxes in Retirement.

In addition you can lower the overall taxes you pay over the course of your life by having funds in investment accounts and being able to pay the favorable capital gains rates on the profits instead of the higher ordinary income tax rates you will pay on retirement accounts.  It is even possible that you will pay no tax on the profits from your investment accounts if you are in the 10 to 15% tax bracket when you recognize the profits.  So while putting money in retirement accounts can reduce your taxes in the year of the contribution of those funds, the taxes are really only deferred until later when you take the money out of the account.  Additionally your money in after tax investment accounts can be accessed before you turn 59 1/2 years of age without paying the 10% early withdrawal penalty you would pay on early distributions from your retirement accounts.

So while retirement accounts have their place, their real value to you is only in deferring and not in minimizing taxes.  However, by using investment accounts you can reduce taxes and increase liquidity allowing you to "jump on" other investment opportunities when they arise.  This is a greatly misunderstood concept but with this information you are now empowered to make good decisions that will benefit you greatly now and in retirement.  I would be happy to help you take advantage of these tax planning opportunities.

With dividends too there are also many tax planning opportunities for you regarding when take money out of your personal or family C Corporation.    Since this income can be taxed to you twice you want to plan to minimize those taxes.  Up front input from an experienced CPA can help you greatly to minimize your tax burden.

For more information on dividends see IRS tax topic 404.

Finally, the IRS added the Net Investment Income Tax starting in 2013.  So you need to take this into consideration too when you are doing tax planning for your investments and retirement.  See my post on this tax by clicking here.

The CPA Superhero wants to help you to succeed in business, life, and in retirement.  While my main business is preparing tax returns, I also work with clients to setup accounting systems to start, manage and develop their business(es) and develop and implement a financial plan. Contact me using my information below to schedule a free introductory consultation up to a half hour. 

Jeff Haywood, CPA

The CPA Superhero
972-439-1955
jeff.jhtaxes@gmail.com

Follow the CPA Superhero on Twitter:


My posts contain general information that does not fit every situation, they are not all inclusive, and as always for your tax situation everything "depends on facts and circumstances."  In addition, the information/IRS requirements are always subject to change.  So call me to talk about your specific facts and circumstances and what you want to accomplish.

Popular posts from this blog

Who Is Watching Your Business? Someone Is. Hopefully It Is You.

Who Is Watching Your Business A few employees from the office went out together for dinner and a movie. It was interesting when the charges at a local restaurant and movie theater showed up on the next business credit card bill. It was reported to me as suspicious and I took it to the owner. Upon investigation it looked like the employees from the office had charged their night out on a company credit card. But how did they do that? Had the owner given them permission? No, he had not. It was discovered that one of the accountants had, without authorization, requested an additional credit card which she used for personal expenses.

Later, at tax time, a local tax-preparer called to ask about an employee's W-2. I could not give information about an employees salary but the preparer found two things interesting. One, some one from the firm I worked for would come to him to have their taxes done rather than have them done in house. Second, the salary and of course the taxes withheld s…

Year End Tax Moves to Reduce Business Profits

Here are some tax planning strategies to help you reduce profits for the year and thus reduce the taxes you will pay you. (Keep in mind if you want to accelerate profit into this year do the opposite of the strategies listed below)

Delay Revenue If your business is an accrual basis tax reporting business delay sending out invoices until next year. For a cash basis tax reporting business delay receipt of income. You may need to call people you have already invoiced to request that they make sure you don't receive their payment before the year end. In reality they can send you a payment before year end and you could receive it after year end so this could benefit both you and your clients/customers.

Accelerate Expenses On the Expense side for an accrual basis tax reporting business make sure you enter all the bills you receive before year-end and make sure they are dated this year. For a cash basis tax reporting business pay as many bills by year-end as possible. If cash is tight m…

The Dreaded IRS Audit...The Reality

There is a fear of an IRS audit.  People have heard all kinds of stories and have many ideas about what will cause an audit and how to avoid it.  For example some fear that taking a deduction that they are entitled to will make them the target of an IRS audit.  I have also heard clients say both that filing on time will prevent an audit and also that filing an extension will avoid an audit.  So what is the reality of IRS audits.  

Who gets audited and why
The IRS audits aroud 1% of tax returns they receive.  That sounds like random selection but there are things that increase your chances of selection.  Ordinary taxpayers with ordinary income and deductions if audited are usually just a random and very unlikely selection.  In fact none of my cleints that can be described this way have ever been randomly selected for an audit.  Most audits are triggered by the unusual or areas of suspect by the IRS.  The IRS itself indicates there are randomly selected audits but most of these are base…