Brokers & Accounts · Intermediate · 5 min

How investment income is typically taxed

You can name the main types of investment income, explain when a gain becomes taxable, and describe how tax is often withheld at source.

Profit isn't net profit

You close a trade with a profit of 1,000. It feels like 1,000 more in your account. But in most countries, part of it belongs to the tax office, and how large that part is depends on where you live, what you traded and how long you held it.

This lesson is not tax advice, and it cannot tell you which rules apply to you. It explains the principles that most tax systems share, so that you know which questions to ask.

Three kinds of income

Investment income usually comes in three forms:

Interest, for example on cash or bonds.
Dividends, the share of profits a company pays out.
Capital gains: a capital gain is the difference between the price you sold at and the price you paid, minus allowed costs.

Most tax systems tax a gain when it is realized. A realized gain is one you have locked in by selling. While you still hold the asset, the gain exists only on paper and is usually not taxed yet.

Many countries collect the tax at source. A German bank, for example, deducts it automatically when you sell or receive a dividend. Foreign dividends often lose a slice before they reach you: the company's home country keeps a withholding tax. Tax treaties between countries may let you credit that against your own tax or reclaim part of it.

Countries differ a lot in how they tax gains. Two examples:

Germany uses a flat rate. Income from capital is taxed at 25%, plus a solidarity surcharge of 5.5% of that tax, and church tax for church members. Each person has a saver's allowance of 1,000 euros a year, 2,000 for married couples filing jointly.
The US distinguishes by holding period. The IRS treats gains on assets held more than one year as long-term, generally taxed at lower rates. Gains on assets held one year or less are short-term and taxed like ordinary income.

1,000 in, 736.25 out

A fictional investor in Germany, not a church member, has already used the annual allowance and realizes another gain of 1,000.

Flat tax: 25% of 1,000 = 250.
Solidarity surcharge: 5.5% of 250 = 13.75.
Total: 263.75, or 26.375% of the gain.

The investor keeps 736.25. For anyone comparing returns, this is the number that counts. A strategy that makes 10% before tax makes about 7.4% after it, under these rules. Had the same gain stayed within the saver's allowance of 1,000 euros, no tax would have been due on it at all. Allowances, rates and surcharges together decide the result, which is why the same trade can leave very different amounts in different countries.

Common mistakes

Planning with gross returns. Taxes and costs both come off before you can spend anything.
Assuming foreign rules match yours. Rates, allowances and holding periods differ widely.
Forgetting withholding tax on foreign dividends. It can often be reduced, but only if you claim it.
Ignoring your broker's country. A foreign broker may not withhold tax for you, so you may have to declare the income yourself.
Relying on old information. Tax rules change often. Check the current rules for your country and year.

The takeaway

Interest, dividends and realized gains are usually taxed, often withheld automatically. The rules depend on your country, so check them there.

Check yourself

Quick quiz

4 questions. Instant feedback, nothing is saved.

1Tap the part of the gain that goes to tax.

Tap the chart.

25% flat tax plus a 5.5% surcharge on that tax gives 26.375%, so 263.75 of 1,000, before any church tax.
2Your shares rose 20% this year, but you have not sold them. In most countries, is that gain taxed now?

Most systems tax realized gains. An unrealized gain on paper usually becomes taxable only when you sell.
3In the US, how long must you hold an asset for its gain to count as long-term?

The IRS treats gains on assets held more than one year as long-term, usually taxed at lower rates than short-term gains.
4You receive a dividend from a foreign company, and part of it is held back. What is that?

Many countries withhold tax at source on dividends paid abroad. Tax treaties may let you credit or reclaim part of it.

of 4 correct.