How is Investment Income taxed?

Investment income is a good problem to have. It means your money is working for you, even

while you’re sleeping, vacationing, or pretending you understand market commentary on the

news. Unfortunately, the IRS is awake for all of it, and different types of investment income are taxed in different ways. Understanding those differences can help you avoid surprises and make smarter decisions throughout the year.

First, not all investment income is created equal. Interest income (from savings accounts, CDs, and bonds) is generally taxed as ordinary income, just like wages. Dividends, on the other hand, may be taxed at lower long-term capital gains rates if they qualify, which means you can pay less tax simply based on how long and where your money is invested. This is one reason two taxpayers with the same income can end up with very different tax bills.

Then there are capital gains, which occur when you sell an investment for more than you paid for it. If you hold an investment for more than one year, you’re usually rewarded with lower long-term capital gains tax rates. Sell sooner, and the gain is taxed at ordinary income rates. (Translation: the tax code likes patience, even if the market doesn’t.) Timing matters, especially when selling assets late in the year.

High-income taxpayers also need to be aware of the Net Investment Income Tax (NIIT). NIIT

is an extra 3.8% tax that applies once your income crosses certain thresholds. This often catches people by surprise because it doesn’t show up on your brokerage statements, but it can quietly increase your overall tax bill. Add in investment income from multiple sources, and things can get complicated quickly.

The good news? Investment taxes aren’t just about reporting - they’re about planning. Strategies like tax-loss harvesting, timing asset sales, and coordinating investment decisions with your overall income can make a meaningful difference. The key is not waiting until tax season to think about it. When investment activity increases, so should your tax awareness (even if that’s less fun than watching your account balance go up).

If you’re earning investment income and wondering how it fits into the bigger tax picture, a

proactive review can help you keep more of what you earn and help you avoid unpleasant

surprises. After all, making money is great. Keeping it is even better.

Quick Example: How Investment Income Gets Taxed

Let’s say Jane earns $150,000 from her job and also has the following investment income in the same year:

• $2,000 in bank interest

• $3,000 in qualified dividends

• $10,000 gain from selling stock she held for 3 years

Here’s how that breaks down for tax purposes:

• The $2,000 of interest is taxed as ordinary income, just like Jane’s salary.

• The $3,000 of qualified dividends and $10,000 long-term capital gain are taxed at

  lower long-term capital gains rates (typically 15% for many taxpayers at this income

  level).

So even though Jane earned $15,000 in investment income, not all of it is taxed the same way. Some is taxed at her highest marginal rate, and some at a significantly lower rate. Purely based on what kind of income it is and how long she held the investment.

Now here’s the part that often surprises people: because Jane’s total income is high, she may also owe the 3.8% Net Investment Income Tax on some or all of her investment income. That extra tax doesn’t show up on brokerage statements, it only shows up when the tax return is prepared.

Bottom line: Investment income can be tax-efficient if you understand the rules. Otherwise, the tax bill may be larger than expected (which dampens the excitement of a “great year” in the market).