This post was written by Dirk Leach for Sure Dividend
Many of my friends, relatives, and acquaintances who also invest don't think much about the type of cash distribution they receive from their investments or the attendant tax treatment of that distribution.
Some of them put their 1099 forms and K-1 forms into the proverbial shoebox and hand it to their tax preparer at tax time never giving a thought about the types of distributions they receive or the taxes that they will pay on those distributions. Heck, they are all just dividends, right?
While I don't believe in specifically tailoring ones investments to minimize the tax consequences, I do believe it is important for investors to understand the basic categories of cash distributions their investments pay out and understand how those distributions are taxed. Dividend taxes matter.
It is important because those distributions are not "just dividends" and how those distributions are taxed varies significantly. In this article, I will provide a brief overview of the most common types of cash distributions and provide some discussion of how each type is taxed as well as how it will affect how much of that distribution you get to keep.
Not "Just Dividends"?
There are five common types of cash distributions that investors receive from their investments:
Interest Distributions - these payments originate from some type of debt security (bonds, bond funds, bank deposits, notes, mortgages, etc.). With the exception of tax-exempt municipal bonds and bond funds, interest payments are typically treated by the IRS as ordinary income subject to earned income tax rates.
Capital Gains Distributions - these payments generally originate from gains or losses on the sale of property or securities (stocks, bonds, real estate, commodities, other real property). Capital gains are either long term if the property/security was held for more than one year or
