There’s a saying in the world of investing not to let the tax tail wag the investing dog. The idea behind it is that investors shouldn’t base their investment decisions on the potential tax consequences alone. However, perhaps there should be another saying to accompany this along the lines of, “Ignore the tax tail, and it may knock your nest egg off the table.”
This is what almost happened to a new widow who came to Frank Davis, president of New Era Financial, for help. Her husband had taken care of the finances and after his death, she sought an advisor to help her.
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“Unfortunately, the new advisor’s mishandling of her account caused her to owe $45,000 in additional income taxes, even though her portfolio went down by more than $86,000,” Davis says.
Anecdotes like this highlight the importance of understanding how brokerage accounts are taxed because even the professionals can get it wrong sometimes.
Knowing how to minimize the impact of taxes is essential to keep more of your money in your pocket. Here are several steps to make sure you are making the right tax decisions with your brokerage account.
— Types of brokerage accounts.
— How are brokerage accounts taxed?
— How to minimize brokerage account taxes.
— Keep your priorities straight.
Types of Brokerage Accounts
Brokerage accounts can be taxed depending on the type of account. There are three main types of brokerage accounts: traditional retirement accounts, Roth retirement accounts and taxable nonretirement brokerage accounts. Each type of account receives a different tax treatment:
— Retirement accounts. These are tax deferred, meaning you pay no taxes on any earnings within the account. Instead, you may owe taxes when you withdraw the money from the account.
— Nonretirement brokerage accounts. Also called taxable brokerage accounts, these don’t have the same tax-deferred advantage. Any money you earn in the account is taxable.
How Are Brokerage Accounts Taxed?
When you earn money in a taxable brokerage account, you must pay taxes on that money in the year it’s received, not when you withdraw it from the account. These earnings can come from realized capital gains, dividends or interest.
The following table summarizes brokerage account tax rates based on the type of earnings.
| Type of Investment Earning | Description | Tax Rate |
| Short-term Capital Gains | Proceeds from selling an investment held for one year or less | Your ordinary income tax rate (10% to 37% in 2025) |
| Long-term Capital Gains | Proceeds from selling an investment held for more than one year | Capital gains tax rates (0% to 20% in 2025) |
| Qualified Dividends | Dividends paid from investments you held for more than 60 days and that meet IRS standards | Long-term capital gains tax rates |
| Ordinary Dividends | Dividends paid from investments you held for less than 60 days or that do not meet IRS standards | Your ordinary income tax rate |
| Interest | Income earned on cash or fixed-income securities like bonds | Your ordinary income tax rate |
How Are Capital Gains Taxed?
Capital gains are the difference between what you sell a stock for and the price you paid when you bought it. If you sell it at a loss, it’s called a capital loss. For example, if you bought a share of stock for $100 then sell it for $150, you’ll owe taxes on the $50 of capital gains. How much tax you owe will depend on how long you held the investment.
The sale of an investment held for one year or less is considered a short-term capital gain by the IRS. These are taxed at your ordinary income rate, which can be up to 37% in the 2025 tax year.
If you hold the investment for more than one year before selling, it is considered a long-term capital gain. These are taxed at more favorable rates no higher than 20% in 2025, and can be as low as 0%.
Both your ordinary income tax rate and capital gains tax rate depend on how much income you earn in the year. Since the difference between the ordinary income tax rate and capital gains tax rates can be significant, it’s important to think carefully before selling an asset you’ve held for less than one year.
Taxpayers with modified adjusted gross incomes of more than $200,000 for single filers, more than $250,000 for married filing jointly or more than $125,000 for married filing separately may owe a 3.8% tax on net investment income earned during the year on top of their ordinary income or capital gains tax.
“There is also tax-exempt income, that is tax-free for the IRS, but may be taxable on your state returns,” says Naomi Ganoe, managing director and private client service practice leader for CBIZ MHM.
She gives the example of an Ohio bond that produces interest income. “That tax-exempt income would be exempt from federal taxes and Ohio taxes. But if you file in New York for income taxes, Ohio tax-exempt interest would not (be) exempt from New York income taxes,” she says.
How Are Dividends Taxed?
Dividends are also taxed in the year they are received when the security is held in a taxable brokerage account. How dividends are taxed depends on if they’re qualified or ordinary dividends, also known as nonqualified dividends.
Ordinary dividends are taxed at ordinary income rates, while qualified dividends that meet certain IRS standards are taxed at the lower capital gains rates. These standards include that you held the investment for more than 60 days and that the dividend is paid by a U.S. corporation or qualified foreign corporation. For more information on qualified dividends, see IRS Publication 550.
How Is Interest Taxed?
Interest is another type of taxable investment income that is earned on cash or fixed-income securities like bonds. Interest income is generally taxed as ordinary income.
But not all bond securities are taxed the same way. For example, “municipal bonds are often federally tax-exempt and, in some cases, may be exempt from state taxes as well,” Davis says.
How Are Retirement Accounts Taxed?
With retirement accounts, taxation is a bit simpler. Traditional retirement accounts that are funded with pretax dollars are not taxed until the money is withdrawn from the account. You can generate unlimited capital gains, dividends or interest within the account and not have to pay any taxes. But you will need to pay ordinary income taxes on any money you withdraw from the account in the year you take the distribution. Individuals who think they may be in a lower tax bracket in retirement prefer to use traditional retirement accounts.
Roth retirement accounts funded with after-tax dollars can offer tax-free withdrawals. Similar to traditional retirement accounts, you pay no income tax on the earnings or capital gains received within the Roth. And if you meet certain requirements, such as having the account for at least five years, you won’t have to pay any taxes when you withdraw the money, either. This can make Roth accounts a great tool for minimizing investment taxes.
Here is the difference between how traditional and Roth retirement accounts are treated for tax purposes:
| Account Type | Contribution Taxation | Withdrawal Taxation |
| Traditional Retirement Accounts | Pretax (you don’t pay taxes on the money you contribute in the year you make the contribution) | Taxed at your ordinary income rate in the year you withdraw |
| Roth Retirement Accounts | After-tax (you pay taxes on the money you contribute in the year you make the contribution) | No taxes |
How to Minimize Brokerage Account Taxes
The most important action to minimize the tax consequences of investments in a brokerage account is to address the wagging tail before it gets near your nest egg. The good news is that there are several strategies you can use to minimize brokerage account taxes.
Use Tax-Deferred Retirement Accounts
The most obvious is to use tax-deferred retirement accounts whenever possible. This is especially useful with investments that may generate significant income or gains and if you’re in a higher tax bracket.
For example, corporate bond funds, which pay interest that’s taxable at both the federal and state level, may be best held in tax-sheltered accounts. Meanwhile, a municipal bond fund, which can be exempt from both federal and state taxes, may be fine in a nonretirement account.
If possible, structure your income and assets so that you can stay in the 12% federal tax bracket, says Nick Bour, founder and CEO of Inspire Wealth. This would put you in the 0% capital gains tax rate.
This strategy is particularly beneficial if you’re planning to start your retirement soon, he says.
Employ Tax-Loss Harvesting
Outside of retirement accounts, you can also minimize taxes by being strategic about when you sell investments. You can avoid the higher short-term capital gains tax rate by not selling appreciated investments until you’ve held them for more than one year.
Another strategy is to use tax-loss harvesting where you take capital losses on investments to offset capital gains. You can sell a security at a loss and use that amount to offset capital gains each year.
If you have more losses than gains, called a net capital loss, you can apply up to $3,000 ($1,500 if married filing separately) of this toward your other ordinary income in any given year. Any losses that exceed the net capital loss threshold in a given tax year can be carried forward.
Watch Out for the Wash Sale Rule
Just be aware of the wash sale rule, which states that if you sell one security at a loss and purchase the same or a substantially similar security within 30 days of the sale — either before or after — the loss is disallowed.
This rule applies even if you buy and sell the investment in separate accounts or at separate brokerage firms. That said, you’re free to sell at a gain and repurchase at any time since there will be no loss to claim anyway.
Choose Tax-Efficient Investments
Another tax-saving strategy is to be careful what investments you use. You can pick certain assets, like municipal bonds or tax-efficient funds, to help avoid taxable distributions. You may also want to avoid big tax generators like dividend-paying companies.
Just be aware that tax-advantaged fixed-income investments often have lower yields than their taxable counterparts. So you may want to compare the tax-equivalent yield to ensure you’re still getting a good deal and not just letting the tax tail wag your investing dog into a less lucrative corner.
Keep Your Priorities Straight
Now that you hopefully better understand how the tax tail wags, you can choose how to manage it. In some cases, it may make sense to make strategic maneuvers to keep the tail in line. But other times, it’s better to keep your eye on other moving parts of your portfolio to optimize your overall return. After all, you only pay taxes if you’re making money.
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Are Brokerage Accounts Taxed? originally appeared on usnews.com
Update 08/20/25: This story was previously published at an earlier date and has been updated with new information.
