Income can be IRS-taxed only once, correct?

Factual Questions
1

Please help my continuing fight against financial ignorance:

If you earn $20,000 in wage/salary, that $20k is subject to IRS income tax. The amount of the tax depends on one’s tax bracket.

After you pay the income tax due, that $20k can never be taxed again, right?

If you save/invest that $20k, any interest, dividends, and/or capital gains can be taxed, but **not **the $20k itself.

[I assume if you’re subject to state income tax, that $20k can be taxed both by the IRS and the state.]

Is that correct?

So if you’re filling out a form that requires reporting of all income in a year, if during that year you sold $20k of a mutual fund, that $20k is **not **regarded as income, because it was already income at the time you received it. After you received it, paid taxes on it, and invested it, it can’t be regarded as “income” again.

For example, if you live on Social Security checks of $2,000/month, that’s $24,000/year income, with maybe additional income of interest/dividends/capgains.

If during that year you sold $20k of a mutual fund, that $20k would not be regarded as “income.” If that year you received $24k in S.S., maybe $1,000 in interest dividends, and you received $20k from sale of mutual fund shares, only the $24k S.S. and the $1k interest would be “income”–the $20k is excluded.

Is that right?

2

If you invest in a mutual fund then that money is tax-sheltered the year you invested. So you will indeed need to pay taxes on it once you sell the shares.

3

Not much time to post now, but the term you want to learn about is ‘cost basis’ with regards to mutual fund taxes.

4

I’m not an accountant.

Anyway, if you had $20k left after taxes and put all that into a mutual fund. One year later, the fund is still worth $20k when you withdraw it, yes, in a simple case, wouldn’t get taxed on that $20k.

There are some complications in that there could have been gains and losses in a fund during the year – if one stock gains and is sold, that could generate a tax liability which may or may not be offset by other stocks that take losses. Also, if part of the fund invests in bonds and, say, the bonds generate $1000 in interest, which is offset by $1000 in losses due to decrease in stocks, you could still have a tax liability. Interest from bonds is regular income and stock gains and losses are typically capital gains and losses, and those don’t normally offset each other.

To simplify the example, say you took the $20k an bought a stock. The stock issued no dividends and at the end of the year, the stock price remained exactly the same. When you sold the stock, you wouldn’t pay taxes, since you had no gains and losses.

5

There are some exceptions. :eek: :smiley:

If you contribute to your Sep-IRA (etc.?) but the IRS disallows the contribution, you be taxed on that income twice – when you put it into the IRA and again when you take it out. (I’m sure there’s some IRS form to reverse this; but my cardiologist advises me to avoid IRS forms).

If you let the IRS calculate your taxes, they will use Zero as the cost basis for all your reported sales. :eek:

6

What about the [del]death[/del] inheritant tax? It is a tax on all assets not just gains.

7

Yes but that is a tax on the transfer of the money to another person.

8

Exactly. It’s not like each dollar has a little indicator on it that tells whether it’s ever been taxed, thereby exempting it from taxation in all future transfers. “Hey, I paid income tax on this money, so these dollars are exempt from sales tax.” Try that the next time you buy something, Saint Cad. And it’s not like inheritances are somehow different.

9

That’s what the OP was asking about. I take my paycheck (so taxes are paid) and stash it under my mattress. When I die assuming the amount of cash is over the death tax limit, is it taxed again? Yes it is.

10

Isn’t that just for retirement accounts? Wouldn’t it be treated like any other investment otherwise?

11

In the *simplest *sense, if a person earns income, that income will not be subject to income tax for that person more than once (but see estate tax discussion below). So everything in the original post is correct.

This is incorrect. Mutuals funds *per se *do not provide tax sheltering. However, if that mutual fund is part of a tax-deferred retirement account such as an IRA or 401(k), then the amount of that investment is not included in taxable income in the year it’s invested. It is taxable when withdrawn.

First of all, it is not an inheritance tax. It is an estate tax. However, it is correct that it is a tax on assets. When someone dies, the value of the assets of the estate over a certain threshold (current $5.43 million) is taxed.

It is not a tax on the transfer. It is a tax on the value of the estate at the time the person dies. The estate pays the tax.

12

You’re right. I assumed one would be buying mutual funds as part of retirement planning, like I have done.

13

I am a dunce in these matters, but I think this was answered.
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14

I think the important way to think of it is that people are taxed, not the money.

15

I was just going to post this, yes the way people talk about money being taxed gives a confusing mental picture. People or entities are taxed for acquiring income, which means whenever money changes hands taxation is happening.

16

I don’t disagree with the above concensus, but want to point out that income can indeed be taxed twice if you are looking at purchasing power. Using the above $20k income, that would be enough to buy a new Honda Civic sedan. Instead of buying the Civic, you buy 200 shares of a $100 stock that doesn’t pay dividends. Over 20 years the stock price doubles to $200 and you sell all of your shares for $40,000. But a new 2035 Honda Civic now costs $40,000 - not unrealistic, as a doubling of price/value over 20 years represents an average inflation of 3.5 percent.

You owe capital gains on that $20,000 “gain”, even though the purchasing power has remained roughly the same. So, you pay your $3,000 in capital gains taxes and you have $37,000 left, which is not enough to buy the same car you could have bought for $20k in 2015.

You can apply the same argument to taxing interest and dividends. No, you don’t pay taxes on income twice if you look at nominal dollars, but you do pay income taxes on the same purchasing power based on real dollars.

17

Just to be pedantic here, “can” is the wrong word. Under our current tax code, you’re correct that it isn’t income-taxed again, but Congress or a state certainly can impose a tax that does so. Something like, “in 2017 and every year thereafter, your income tax shall include a 5% surtax on all of the income that you earned in the prior year.” That’s unwieldy, but it’s not impossible.

18

In addition to the other corrections to this statement, it’s also not a tax on gains. I think any existing gains are wiped out for tax purpose (the basis in increased to the value at the time of death). For example, if you bought a stock at $100 and it grew to $250, and you died, your beneficiaries would get the stock at a tax basis of $250, so only gains from that point would be taxed. If your total estate was below the threshold for estate taxes, that gain wouldn’t get taxed at all.

19

So when I said it is not a tax on gains, you are correcting me to say it is not a tax on gains?

20

“Income” is taxed, not “money” (We’re talking income tax, I assume). When you earn it as wages, that’s income.

If you buy something, then sell it later for more that you bought it, that extra is “capital gains” and also taxed. Yes, the original amount to buy the item (mutual fund, gold brick, etc.) is not taxed. But then, it’s up to you to preserve the documentation showing how much the original price was.

If you bought a series of mutual funds or stocks at different prices, then there are a plethora of accounting logic rules for how to calculate the profit - average, first-in-first-out, etc. If you lose money, there are interesting rules about how to deduct that loss from other income (typically, subtract capital losses from capital gains).

However, if you hire Rodrigo as your gardener, or your son, or nephew, then you pay for that work with taxed income, and then they (should) report that as income and also pay a tax. (Unless the house and garden are an investment, which opens a whole long list of additional issues about deducting expenses)

Similarly, you pay property taxes, sales taxes, etc. with taxed income unless the expenses are for a business investment.

The other point is - I assume savings plans like 401K and IRA are like Canadian RRSP - you put $X in, you deduct $X or a fraction off your taxable income. The money that is in that account, typically in mutual funds or bond funds, is therefore “untaxed income”. When you remove that money, both the original amount and the growth are taxable - since you did not pay taxes on it when it went in. The logic is that it went in when you were earning a lot of money, high taxes, at retirement, your other income is much lower (no wages) so you will pay less taxes on that income/withdrawal.