Taxes, you may have heard of them. Your parents have to pay them, your grandparents have to pay them, most everyone has to pay them in their lifetime, but what are taxes?
Taxes are the amount of money the government requires you to pay. Taxes are used by the government to fund schools, police departments, road construction, general infrastructure, etc... There are a ton of different taxes, but today we will just be focusing on taxes on investments.
Remember what we learned in the last Bite about capital gains. There are two classifications of gains: long-term and short-term. If you hold an investment for more than a year, it is considered a long-term investment. A short-term investment is one that has been held for less than a year.
These two classifications are important because they are taxed differently. Long-term capital gains can be taxed at a lower rate than short-term in order to provide investors an incentive to hold an investment for a longer period of time. By holding an investment for less than a year, you may have to pay more in taxes.
The amount you pay in taxes on a capital gain is also determined by your income level. These two factors, long-term/short-term classification and income, determine your total tax rate on that capital gain. In order to see the total amount you or your parents would pay on a capital gain, you can refer to this table by Nerd Wallet.
In the instance you lose money on the investment (a capital loss), you do not have to pay taxes because you did not earn any money from the investment.
This classification between long and short-term is determined by the Internal Revenue Service or IRS. The IRS is in charge of making sure everyone has paid their taxes.
There is much more to taxes that we will cover later on, but understanding the basic implications of taxes when selling an investment is important to know as you start off.
Next up, we will be covering diversification to mix things up.