Written by Jonathan Vance, CFP®, EA
The old saying is true, there are only two certainties in life; death and taxes.
However, just because taxes are certain doesn’t mean that we can’t have some control over them. Throughout my studies to become an Enrolled Agent, the IRS repeatedly mentions that taxpayers should use the legal framework within the Internal Revenue Code to the best of their advantage.
For a business owner, that might mean having a clear understanding of how the qualified business income (QBI) deduction is impacted by traditional vs Roth Solo 401(k) contributions.
For a farmer, that might mean understanding how Section 179 deductions impact the net-after-tax cost of equipment replacements.
And for all of us as individuals (including farmers & business owners), it includes understanding how various investments are taxed.
The purpose of this post is to provide an overview of how investment types are taxed and what we can do each year to manage the taxes caused by our investments.
Note: This post is primarily focused on how investments are taxed when they’re held in a taxable brokerage account in the United States.
Imagine you’d like to have broad market exposure to United States stocks and you’re weighing two options:
For simplicity, let’s assume both options carry the same level of risk and generate identical annual returns. We’ll also set dividends aside for now and assume that 100% of the return characteristic will be generated by price appreciation, also known as capital gains.
Let’s assume that both solutions provided a 10% return in 2025.
The ETF was purchased in December of 2024, held all year, and sold once it qualified for long-term capital gain treatment.
Meanwhile, the actively managed account hit that same 10% return by frequently trading and solely realizing short-term capital gains.
Here’s how that 10% return would look after federal taxes depending on your tax bracket. We’ll leave out state taxes since Missouri no longer taxes capital gains.
Note: These figures illustrate the federal "tax drag" on a 10% return, assuming the account manager generates only short-term gains (taxed at ordinary rates) and the ETF generates only long-term gains. The 37% bracket includes the 3.8% Net Investment Income Tax (NIIT). This is a simplified educational example and should not be considered tax or investment advice.
On your year-end brokerage statement, both solutions might show the same +10% return for 2026. However, the true story is found in what you actually keep. When all else is equal, the strategy that prioritizes long-term capital gains may leave you with significantly more "spendable" wealth than one relying on short-term gains.
Most of us don’t just invest money for one year, we invest for decades. Let’s look at an example of how that tax drag can significantly alter long-term outcomes.
Let’s assume that you’re in the 37% bracket above and invested $100,000 for 20 years in each solution. Assuming a straight-line return at the after-tax rates we calculated earlier (5.92% and 7.62%, respectively), here’s our approximate account balances in 20 years:
The tax managed solution yields a staggering additional ~37% over 20 years!
Of course in reality, these two strategies will perform differently year-to-year, and I am not suggesting that your investment choices be made strictly off of tax treatment.
I also won’t dive into the "active vs. passive" debate here. That’s an excellent conversation by itself, but beyond the scope of this post (you can read more about my investment philosophy if you’re interested).
However, I hope this illustrates the “tax hurdle” effect. The more tax drag you experience, the harder your underlying investments have to work just to break even with a more tax-efficient counterpart.
Now let’s ignore capital gains and losses and focus strictly on investment income.
We’ll look at how four common sources of income are taxed for a Missouri resident in 2026, using the same federal tax brackets as before. The income sources we’ll compare are:
In each scenario, we’ll assume that you receive $100 of gross income. Here’s how much of that $100 you’d have left after you pay taxes at three different marginal tax brackets:
Note: These figures are for illustrative purposes and reflect 2026 tax law assumptions for a Missouri resident. They assume the highest state marginal rate (4.7%) and, for the top bracket, the 3.8% Net Investment Income Tax (NIIT). Specific tax situations may vary from the examples above.
As you can see, if each of these solutions pays the same $100, the actual net amount that we get to keep depends on how that $100 is taxed and what our unique tax situation looks like.
Similar to what I mentioned above, please do not make investment decisions solely based on tax considerations. Choosing to own any single investment should consider your individual goals, risk tolerance, and other factors.
However, do fully understand the tax treatment of various investment vehicles to arrive at the most tax-efficient solution for your unique situation. It can provide a very real impact!
Up until this point, we’ve been focusing on the tax treatment of investments held in a taxable brokerage account. But it’s important to note that many individuals have a portion of their asset base held in other tax advantaged accounts (such as 401(k)s, IRAs, Health Savings Accounts, etc.)
Assets held within these account types are not taxed on account activity, but rather carry tax implications on contributions and distributions. This can provide a unique opportunity for us to “locate” certain assets inside tax advantaged accounts while holding our most tax efficient investments in taxable accounts.
Let’s look at a quick example of applying asset location concepts:
Suppose you have the below accounts:
Further, suppose that you need exactly $30,000/year in income from these investments, you’re taking all $30,000 from your Traditional IRA, and you never plan to spend any money from your Roth IRA. You’d like that account to grow as much as possible to eventually get passed to your heirs.
In this simplified example, asset location principals would suggest that you “locate” a higher percentage of your equity (growth-oriented) investments into the Roth IRA to take advantage of the long-term tax free rules that apply to that account while locating more of your bond (stable, fixed income) assets in your Traditional IRA since you are relying on that account to fund near-term distributions.
The logic is simple: You want the most aggressive growth to occur in your most tax-advantaged environment.
However, admittedly, the execution can be more nuanced. Similar to what I’ve mentioned in each of the sections above, making asset location decisions should consider your full financial plan variables, not simply what might be the most tax-efficient for one given year.
The best asset location plans are driven by tailored long-term financial plans.
Establishing an annual capital gains budget might seem like a minor administrative task, but it is actually a prime opportunity for strategic tax planning.
Beyond simply pushing you into a higher marginal bracket, failing to budget for capital gains can trigger several "hidden" costs:
It’s easy to assume that "tax loss harvesting", or selling assets at a loss to offset gains or up to $3,000 of ordinary income, is a universal win. However, there are several cases where you may not want to partake in tax loss harvesting.
Consider this scenario for a married couple, both age 61, with the below income sources in 2026:
Conventional wisdom suggests harvesting losses to "offset income," but in this case, I’d argue that would be a missed opportunity.
The $30,000 of interest and IRA distributions are already fully covered by the $32,200 standard deduction, meaning no federal or Missouri state tax is owed on that ordinary income.
Further, the total income of $80,000 remains within the 0% tax on capital gains threshold ($98,900 in 2026 for married filing jointly), and Missouri does not tax capital gains.
If you harvested losses here, you would be offsetting income that is already taxed at 0%.
Here’s why that might be a mistake:
When you realize capital losses, you often “reset” your cost basis at a lower level when you purchase new assets with the proceeds.
However, all else equal, we would actually prefer a higher cost basis for future tax control and flexibility. In the example above, we would likely prefer “stepping up” our cost basis to a higher amount while paying 0% in tax in the process.
Tax planning is rarely one-size-fits-all. While rules of thumb provide a starting point, the best decisions are tailored to your specific financial landscape.
As we’ve explored, there is no single "magic button" to eliminate taxes, but you can do your best to minimize them by following these core principles:
Tax planning is a game of tailoring. While the Internal Revenue Code is complex, it also provides the framework to build a more efficient financial future if we understand how to apply the rules.
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