Taxes & Earnings

The U.S. tax system is complicated and the rules surrounding it change frequently. The majority of the time, however, how you're taxed is based on the source of your income. Most earned income, which includes wages, interest and qualified withdrawals from a retirement plan, are taxed at a specific rate that is based on your filing status and tax bracket.

Earnings on stocks, bonds and cash are considered investment income and are taxed differently, depending on the asset class, the issuer and the type of earnings. However, investment earnings in a tax-deferred account aren't taxed when they're paid but when they're withdrawn. The tax is figured at the same rate as your earned income.

The profit or loss realized when you trade a security is taxed as a capital gain or loss. If you own the stock or bond for longer than one year, you will have a long-term capital gain when you sell it. If you own the security for less than a year before you sell, you will have a short-term capital gain. Short-term capital gains are taxed at your regular rate, while long-term capital gains are typically taxed at a lower rate than your earned income.

Currently, qualifying dividends paid by most U.S. companies are taxed at a maximum rate of 15%, though dividends on REITs are taxed as ordinary income.

Interest paid on corporate bonds, certificates of deposit, and other cash equivalents is taxed at the same rate as your earned income at federal, state and local levels. If you buy government-issued bonds, you generally enjoy at least some tax-free investing. Interest paid by U.S. Treasuries is typically exempt from state and local taxes, while municipal bond interest is generally exempt from federal income tax. If you live in the state that issues the municipal security, you may be exempt from state income taxes on the interest as well.

With mutual funds, income distributions on funds that invest in municipal bonds are exempt from federal tax, as well as state and local taxes if you live in the state that issues the bonds. However, some municipal bond funds do carry the risk of potentially subjecting investors to the Alternative Minimum Tax (AMT). Unlike investing directly in U.S. Treasuries, income distributions on Treasury funds are not tax-exempt. Nor are income distributions on corporate and most agency bonds.

An important caveat is that tax-free investments typically offer lower yields than those that are taxed. Depending on your risk tolerance and financial objectives, taxable investments may be more appealing than tax-exempt government securities, especially in tax-deferred accounts.

Investors should consider the investment objectives, risks, charges, and expenses of mutual fund carefully before investing.A prospectus contains this and other information about the fund and is available through www.scottrade.com or through a Scottrade branch office. The prospectus should be read carefully before investing

Scottrade does not provide tax advice. This material is for informational purposes only. Please consult your tax or legal advisor(s) for questions concerning your personal tax or financial situation.