Taxes 101
Charles Carlson, CFA
Contributing Editor, Dow Theory Forecasts

Taxes can be a confusing subject, especially for new investors. The following are five basic rules governing taxes and your investments:

1. Dividend income that you receive from your investments is taxed as ordinary income. For example, if you are in the top tax bracket (39.6%), you will pay approximately 40 cents in taxes for every dollar in dividends you receive. You will pay this tax even if you reinvest those dividends to buy additional shares.
2. If you hold investments for 12 months or more, you receive a tax break when you sell. The most you will pay in capital-gains taxes on investments held 12 months or more is 20%. Remember: You pay this capital-gains tax only when you sell your investments. If your investment rises 40% during the year, but you do not sell, you don?t owe any taxes for that year (other than taxes on dividends you might have received).
3. When you sell stock, you must determine a "cost basis" for tax purposes. There are two methods for determining your cost basis: the "first-in, first-out" method, and the "specific-share" method. Under the first-in, first-out method, you sell the shares that you bought first. This method will probably result in a higher tax bill since the shares you bought first probably have achieved the most gains. A more tax-friendly approach is using the specific-share method. This method affords you the ability to choose shares to sell that may not have appreciated as much, thus allowing you to limit your taxes on capital gains.
4. If shares you purchased undergo a stock split, you must adjust your cost basis for the split. For example, if you buy 100 shares of a stock at a cost of $50 per share, and the stock splits 2-for-1, the new cost basis of your shares is now $25 to reflect the stock split.
5. If you receive shares of stock in an inheritance, the cost basis of the shares is "stepped up" to you. In other words, your cost basis on the shares you inherit is the price of the shares on the date of the transfer of ownership from the deceased.

 More about taxes:
 Taxes 101
 Investing With Uncle Sam's Money
 Tax Tips for Stock and Fund Investors
 Uncle Sam, Investment Partner

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