Show pageOld revisionsBacklinksBack to top This page is read only. You can view the source, but not change it. Ask your administrator if you think this is wrong. ======Federal Tax====== Federal Tax refers to the taxes levied by a country's national government on the income of individuals and corporations. For investors in the United States, this means the taxes imposed by the U.S. federal government, administered by the [[Internal Revenue Service (IRS)]]. In Europe, these are simply the national-level taxes. These taxes are the primary engine of government funding, paying for everything from national defense and infrastructure projects to social programs like [[Social Security]] and [[Medicare]]. Think of it as the membership fee for living in an organized, functioning society. For investors, federal taxes are a critical and unavoidable factor that directly influences investment returns. Understanding how they work isn't just for accountants; it’s a fundamental part of making smart financial decisions and maximizing the real, after-tax money that ends up in your pocket. ===== How Federal Taxes Impact Investors ===== Taxes are one of the "three certainties" in life, and for investors, they pop up in two main areas: on the profits your investments generate and on the profits of the companies you invest in. ==== Taxes on Your Investment Gains ==== When you sell an investment for more than you paid, or when a company you own shares in pays you a dividend, Uncle Sam wants his cut. The amount you pay depends on the type of income and, crucially, how long you held the investment. * **Capital Gains:** This is the profit you make from selling an asset—like a stock, bond, or piece of real estate—for a higher price than you bought it for. The U.S. tax code splits this into two categories, creating a huge incentive for patience: - **Short-Term Capital Gains:** If you hold an asset for //one year or less// before selling, your profit is taxed at your regular [[ordinary income tax]] rate, which can be quite high. This discourages rapid, speculative trading. - **Long-Term Capital Gains:** If you hold an asset for //more than one year//, your profit is subject to the much friendlier [[capital gains tax]] rates, which are significantly lower for most investors. This is where value investors have a natural advantage; their "buy and hold" philosophy is rewarded by the tax code. * **Dividends:** This is a portion of a company's profits paid out to its shareholders. Like capital gains, dividends get different tax treatments: - **[[Qualified Dividends]]**: Most dividends from U.S. corporations and many foreign ones fall into this category. They are taxed at the same favorable long-term capital gains rates. - **Non-Qualified Dividends**: These are taxed at your higher, ordinary income tax rate. * **Interest Income:** The interest you earn from savings accounts, CDs, and most types of bonds is generally taxed as ordinary income. ==== Taxes on Companies You Invest In ==== Before a company can even think about paying you a dividend or reinvesting profits to grow the business (which increases the stock price), it must first pay its own taxes. The main tax here is the [[corporate income tax]], a tax on a company's profits. This is a direct hit to the company's [[earnings]]. For example, if a company earns $100 in profit and the corporate tax rate is 21%, it pays $21 in taxes, leaving only $79 for its shareholders. As a value investor, when you analyze a company, you're not just looking at its revenue; you're looking at its after-tax profit. A company's ability to legally minimize its tax burden through savvy management can be a sign of efficiency. Always check a company's [[effective tax rate]] in its financial statements to see what it //actually// pays. ===== Using Tax-Advantaged Accounts to Your Advantage ===== Governments want citizens to save for retirement, so they've created special accounts that offer powerful tax breaks. Using these [[tax-advantaged accounts]] is one of the most effective ways to build long-term wealth. The two main flavors are "pay tax now" and "pay tax later." ==== The "Pay Tax Now" Approach (Roth) ==== With accounts like a [[Roth IRA]] or a [[Roth 401(k)]], you contribute money that you've already paid taxes on (after-tax dollars). The magic happens later: your money grows completely tax-free, and when you take it out in retirement, you owe zero federal tax. This is a fantastic option if you believe your tax rate will be higher in the future than it is today. ==== The "Pay Tax Later" Approach (Traditional) ==== With accounts like a [[Traditional IRA]] or a [[Traditional 401(k)]], the roles are reversed. You contribute money //before// it's been taxed (pre-tax dollars), which lowers your taxable income for the current year—giving you an immediate tax break. Your investments grow tax-deferred, but you will pay ordinary income tax on all withdrawals you make in retirement. This is generally a good choice if you are in a high tax bracket now and expect to be in a lower one when you retire. ===== A Value Investor's Takeaway ===== Taxes are not just an afterthought; they are a central component of your investment return. Ignoring them is like navigating with an incomplete map. Fortunately, the core philosophy of value investing—patience, discipline, and a long-term perspective—is naturally tax-efficient. By holding high-quality businesses for many years, you not only allow your investments to compound but also ensure your eventual profits are taxed at the lower long-term capital gains rates. By utilizing tax-advantaged accounts, you can further shelter your growing [[net worth]] from the taxman. The goal isn't tax avoidance, but tax //awareness//. Understanding the rules helps you keep more of what you earn.