As the tax season approaches, many individuals are gearing up to submit their income tax returns for 2024. Given the favorable financial conditions of the previous year, this time of the year can feel both exciting and nerve-wracking for taxpayers—especially those who have accrued income from various interest-bearing investments. The deadline for filing federal income tax returns is April 15, and although extensions are available until October, any taxes owed must be settled by this date to avoid penalties.
In 2024, many investors benefited from a sustained period of attractive yields, thanks to high-yield savings accounts, certificates of deposit (CDs), and money market funds. These traditional savings products offered annual percentage yields exceeding 5% in some cases, allowing individuals to earn significant interest on their deposits. However, this newfound income involves a crucial tax implication that often catches taxpayers off guard. Financial experts emphasize that interest income is taxed as ordinary income, meaning that those in the highest tax brackets could be paying up to 37% on these earnings.
Catherine Valega, a certified financial planner, highlights how many investors overlook this aspect of their financial operations. “It’s an esoteric form of income that people tend to forget about until they get their tax documents,” she remarks. This sudden realization of extra taxable income can lead to confusion and stress, especially for those who were not adequately prepared.
As part of the tax preparation process, investors should be proactive in monitoring the arrival of important tax forms in the mail. Financial institutions are required to send a Form 1099-INT to clients who have earned at least $10 in interest during the previous year. This document provides the necessary details about the interest earned, which will be integral to accurately filing a tax return.
Moreover, for investors who held dividend-paying stocks, it is essential to keep an eye out for a Form 1099-DIV or a consolidated 1099 from their brokerage. Qualified dividends are treated more favorably in tax terms, potentially being taxed at lower capital gains rates, ranging from 0% to 20% based on an individual’s tax bracket. Tim Steffen, director of advanced planning at Baird, advises patience during this stage. “Don’t rush to file your tax return until you have received all pertinent documents,” he notes, emphasizing that these documents typically arrive between mid-February and mid-March.
Taxpayers involved in partnerships should be especially vigilant during tax season. Unlike C-corporation earnings, which are taxed at the corporate level, partnerships provide unique tax obligations for their investors. Limited partners receive Schedule K-1 forms that report their share of the income. These forms may not arrive until March or even later, complicating the filing process if a taxpayer attempts to file their taxes beforehand. Unfortunately, failing to wait for the K-1 can necessitate an amendment of the tax return later, which can not only incur additional costs but also add complexity to what should be a straightforward process.
In preparation for filing taxes, it’s crucial to take stock of where all income-generating assets are held. Some limited partnership interests held in Individual Retirement Accounts (IRAs) may trigger a tax liability known as “unrelated business taxable income.” This situation dictates that the retirement account itself must file a tax return, which can become a daunting task for many.
Additionally, investors should double-check the basis reported by brokerages on their capital gains. Mistakes can occur in calculations, especially if investments have been reinvested over time. Accurate reporting is paramount, and any discrepancies can lead to regrettable financial outcomes.
Furthermore, state tax implications warrant attention. Some assets may have different tax treatments at the state level compared to federal regulations. For example, while interest income from U.S. Treasury securities is exempt from state and local taxes, it remains subject to federal taxes.
Tax season in 2024 presents a double-edged sword for many investors. With the opportunity to earn significant returns comes the responsibility to report these earnings accurately. By being proactive and thoroughly preparing through the careful collection of tax documents, understanding potential tax liabilities, and recognizing state tax implications, individuals can avoid unnecessary complications and make the most of their investment incomes.