Types of Income Tax
An individual may be subject to one of the following four types of income tax:

  1. Ordinary income - this includes all income earned from salary, commission and business income. Some investment gains, such as bond interest and withdrawals from traditional IRAs and company retirement plans, are taxed at "ordinary income" rates.

  2. Capital gains - this refers to income resulting from the appreciation of a capital asset (e.g., stocks, real estate, coins). Capital gains are not realized until the asset is sold. Capital gains are classified as either short- or long-term:
    • Short-term - assets held for 12 months or less are considered short-term capital gains and are taxed at ordinary income rates.

    • Long-term - assets held for longer than 12 months benefit from reduced tax rates (based on your marginal tax bracket). In 2013, taxpayers within the 10 to 15 percent bracket foot a bill of 10% on long-term capital gains while taxpayers above that bracket (25%+) are taxed at a rate of 20%.

  3. Dividends - prior to 2003, dividends were taxed at ordinary income rates along with bond interest. In 2013, "qualified" dividends are taxed like capital gains, with taxpayers within the 25 to 35 percent bracket required to pay 15% while those under 25 percent receive a tax bill of 0%.

  4. Passive income - income from sources - such as real estate limited partnerships or directly owned (but professionally managed) real estate - is taxable at ordinary income rates and can only be reduced by passive losses, not by capital gains losses.
Holding Period and Cost Basis

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