Haven’t thought about taxes yet in 2026?

Tyler Kert
Tamarack Wealth Management

It’s that time of year again. It’s time to gather your tax documents, file your return, and hopefully not be surprised by the result. If you’re worried about your tax bill for 2025, there isn’t much you can do now to change the past. Instead, put energy towards tax planning now. You have plenty of time to make changes and improvements for 2026. 

In this article, I want to clear up two concepts that I’ve found are constantly misunderstood: how tax brackets actually work, and why reinvested dividends in taxable accounts can quietly erode your returns. First, let’s talk about tax brackets.

The United States has had a progressive tax system since the early 1900s. The modern federal income tax was established in 1913 after the ratification of the 16th Amendment. At that time, the top marginal tax rate was just 7 percent. Yes, I wish I could go back to that time too. But, over the decades, rates rose dramatically to a peak at over 90 percent during World War II. In 1981, the top tax rate was still 70% - almost double the current highest tax rate today. Rates have gradually settled into the modern structure with a current top federal bracket of 37%. 

Our current system remains progressive, which just means that income is taxed in layers. As your income rises, only the dollars that fall into higher brackets are taxed at higher rates. This is where people are often confused.

I frequently hear people say, “I don’t want to earn more because it will push me into a higher bracket.” That’s not how it works. Moving into a higher bracket does not retroactively increase the tax on your lower income. It only affects the portion above the threshold. For example, if a married couple makes slightly more and moves from the 22 percent bracket into the 24 percent bracket, only their income above that bracket cutoff is taxed at 24 percent. The rest stays taxed at lower rates. You never lose money by earning more. You simply pay a slightly higher rate on the top slice.

Understanding this layered system matters when you are considering things like Roth conversions or large IRA distributions. Don’t let the fear of “jumping brackets” stop you from making strategic decisions. 

Now, let’s switch gears and talk about another highly misunderstood tax concept. This one regularly surprises even experienced investors. Many investors assume that if dividends are automatically reinvested, there is no tax consequence. After all, they never saw the cash. It went right back into the investment.

Unfortunately, the IRS does not care whether you reinvested the dividend. If it was paid to you in a taxable brokerage account, it is taxable income in the year it was received. Often, investors don’t realize this because they don’t understand how the dividends affect their tax return. Many people think of their “investments” and their “income tax” in separate categories. But the truth is, they are linked and investments in a taxable brokerage account have a direct impact on your tax liability. 

These taxes owed on dividends generated from a taxable account create what is known as a “tax drag” problem. Let’s say you own a high-dividend mutual fund in a taxable account that yields 4 percent annually. Even if you reinvest every dollar, you’ll owe tax on that 4 percent each year. Over time, that annual tax bill reduces your overall return. The higher your tax bracket, the larger the drag.

Now, compare that to holding the same investment inside a qualified account like an IRA or 401(k). In those accounts, dividends are not taxed each year. They grow tax-deferred (or tax-free in a Roth). The compounding works uninterrupted.

This is where asset location becomes critical. Taxable accounts are generally better suited for tax-efficient investments like ETFs and positions that distribute minimal dividends. Dividend-heavy funds, REITs, and bond funds are often better placed inside retirement accounts where their income can compound without triggering annual tax bills.

A well-designed portfolio is not just about allocation (stocks versus bonds) but also about location. Where you hold an investment can matter almost as much as what you hold.

If you haven’t considered your asset location, look at last year’s tax return. How much of your taxable income came from dividends? Are you sitting on high-yield investments in a brokerage account while your IRA holds low-yield growth funds? That might be backwards.

Understanding how brackets truly work and how reinvested dividends are taxed can help you keep more of what you earn and allow your investments to compound more efficiently over time. At the end of the day, it’s not what you earn that matters, it’s what you keep.

This material is for informational purposes only and does not constitute financial, investment, or tax advice. Please consult your tax advisor or financial planner to discuss your specific circumstances before making any decisions. Securities offered through Cetera Wealth Services LLC, Member FINRA/SIPC. Advisory services offered through Cetera Investment Advisers LLC, a registered investment adviser. Cetera is under separate ownership from any other named entity.

Tyler Kert, a financial advisor and CPA, provides financial planning and tax consulting services at Tamarack Wealth Management in Cashmere, WA.