💲Intro to Investments Unit 13 – Investing Taxes and Regulations

Key Investment Concepts

• Investment involves allocating resources (money) with the expectation of generating income or profits
• Risk and return are fundamental concepts in investing, with higher risk investments typically offering higher potential returns
• Diversification spreads investments across different asset classes (stocks, bonds, real estate) to manage risk
• Asset allocation determines the mix of investments in a portfolio based on an investor's goals, risk tolerance, and time horizon
• Compound interest is the interest earned on both the initial principal and the accumulated interest over time
• Dollar-cost averaging involves investing a fixed amount of money at regular intervals, regardless of market conditions
• Liquidity refers to how easily an investment can be converted into cash without affecting its market price

Types of Investments and Their Tax Implications

• Stocks represent ownership in a company and are subject to capital gains tax when sold for a profit
  • Qualified dividends from stocks are taxed at a lower rate than ordinary income
• Bonds are debt securities that pay interest to investors, which is taxed as ordinary income
  • Municipal bonds issued by state and local governments offer tax-exempt interest at the federal level
• Mutual funds pool money from many investors to purchase a diversified portfolio of securities
  • Capital gains distributions from mutual funds are taxed as either short-term or long-term capital gains
• Exchange-traded funds (ETFs) are similar to mutual funds but trade on stock exchanges like individual stocks
• Real estate investments can generate rental income, which is taxed as ordinary income, and capital gains when the property is sold
  • Real Estate Investment Trusts (REITs) allow investors to invest in real estate without directly owning property
• Derivatives, such as options and futures contracts, have complex tax implications depending on the specific instrument and holding period

Understanding Investment Income

• Dividends are payments made by companies to shareholders and are typically taxed as ordinary income
  • Qualified dividends, which meet certain criteria, are taxed at a lower rate than non-qualified dividends
• Interest income from bonds, CDs, and savings accounts is taxed as ordinary income
  • Tax-exempt interest from municipal bonds is not subject to federal income tax
• Rental income from real estate investments is taxed as ordinary income, but expenses related to the property can be deducted
• Royalties from intellectual property (patents, copyrights) are taxed as ordinary income
• Distributions from partnerships and S corporations are passed through to the individual investors and taxed based on their share of the entity's income

Capital Gains and Losses

• Capital gains occur when an investment is sold for more than its purchase price, while capital losses occur when an investment is sold for less
• Short-term capital gains, from investments held for one year or less, are taxed as ordinary income
• Long-term capital gains, from investments held for more than one year, are taxed at a lower rate than ordinary income
• Capital losses can be used to offset capital gains, and if losses exceed gains, up to $3,000 can be deducted against ordinary income
• Tax-loss harvesting involves selling investments at a loss to offset capital gains and reduce tax liability
  • Wash sale rule prohibits claiming a loss on a security if a substantially identical security is purchased within 30 days before or after the sale

Tax-Advantaged Investment Accounts

• Traditional IRAs allow for tax-deductible contributions, with taxes deferred until withdrawal in retirement
  • Withdrawals before age 59½ may be subject to a 10% early withdrawal penalty
• Roth IRAs allow for after-tax contributions, with qualified withdrawals in retirement being tax-free
• 401(k) plans are employer-sponsored retirement accounts that allow for pre-tax contributions and tax-deferred growth
  • Many employers offer matching contributions up to a certain percentage of the employee's salary
• 529 plans are tax-advantaged investment accounts designed to save for education expenses
  • Contributions grow tax-deferred, and qualified withdrawals for education expenses are tax-free
• Health Savings Accounts (HSAs) allow for tax-deductible contributions, tax-free growth, and tax-free withdrawals for qualified medical expenses

Regulatory Bodies and Their Roles

• Securities and Exchange Commission (SEC) oversees the securities industry, enforces federal securities laws, and protects investors
  • Requires public companies to disclose financial and other information to the public
• Financial Industry Regulatory Authority (FINRA) is a self-regulatory organization that oversees broker-dealers and their registered representatives
• Commodity Futures Trading Commission (CFTC) regulates the derivatives markets, including futures, options, and swaps
• Internal Revenue Service (IRS) administers and enforces federal tax laws, including those related to investment income and transactions
• State securities regulators enforce state-specific securities laws and protect investors within their jurisdiction

Important Investment Regulations

• Securities Act of 1933 requires companies offering securities to the public to register with the SEC and disclose financial information
• Securities Exchange Act of 1934 created the SEC and grants it broad authority to regulate the securities industry
• Investment Company Act of 1940 regulates mutual funds and other investment companies to protect investors
• Investment Advisers Act of 1940 regulates investment advisers and requires them to register with the SEC and adhere to fiduciary duties
• Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 introduced sweeping reforms to the financial industry following the 2008 financial crisis
  • Created the Consumer Financial Protection Bureau (CFPB) to protect consumers from abusive financial practices
• Regulation Best Interest (Reg BI) requires broker-dealers to act in the best interest of their retail customers when making investment recommendations

Compliance and Reporting Requirements

• Public companies must file annual (Form 10-K) and quarterly (Form 10-Q) reports with the SEC, disclosing financial and operational information
• Insider trading, or trading based on material, non-public information, is illegal and can result in civil and criminal penalties
• Registered investment advisers must file Form ADV with the SEC, disclosing information about their business practices, fees, and conflicts of interest
• Broker-dealers must maintain accurate books and records and provide regular account statements to clients
• Anti-money laundering (AML) regulations require financial institutions to implement programs to detect and prevent money laundering activities
• Foreign Account Tax Compliance Act (FATCA) requires foreign financial institutions to report information about U.S. account holders to the IRS
• Payment Card Industry Data Security Standard (PCI DSS) sets security requirements for companies that accept, process, or store credit card information