Taxes on Stocks Explained
- Taxes on stocks must be paid when an individual earns dividends as a shareholder or sells stocks for a profit.
- Profit earned from selling stocks that were held for less than a year is taxed at the individual’s ordinary income tax rate, while profit earned from selling stocks that were held for a year or longer is taxed at the capital gains tax rate of 0%, 15%, or 20%.
- The tax rate for ordinary dividends corresponds with the individual’s regular income tax rate according to their tax bracket, whereas the tax rate for qualified dividends owned for a specified period is 0%,15%, or 20%.
- Taxpayers can lower their tax bill for stock sales by deducting capital losses from capital gains, holding onto assets for longer than a year, holding stock shares in tax-advantaged accounts, and hiring a tax professional for tax help.
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What Are Taxes On Stocks?
Taxes on stocks are owed to the IRS for the year that the long-term and short-term capital gains on the asset are realized, and/or for the tax year during which dividends are paid.
Capital Gains Vs. Dividends
There are different tax advantages to investing in various types of stocks, so it is important that individuals learn about the benefits of buying and selling stocks and how to make the most of their investment money.
Capital Gains Tax
When taxpayers think about investing in stocks, they likely envision purchasing a stock for a low price and selling it for a greater value. In this situation, the taxpayer would likely owe capital gains taxes on the profit of the sale. Selling a stock for less than the amounts initially paid, however, would result in capital losses.
Short-Term Vs. Long-Term Capital Gains
Capital assets like stocks are taxed differently depending on how long the asset was held before it was sold.
- Short-Term Capital Gain
If the taxpayer sells the asset within the first twelve months of purchasing, this transaction would generate a short-term capital gain. Short-term capital gains are taxed at the same personal income tax rates that are dependent on an individual’s taxable income and filing status, including 10%, 12%, 22%, 24%, 32%, 35%, and 37%.
- Long-Term Capital Gain
Taxpayers who sell a capital asset after holding it for more than one year will be required to pay long-term capital gains tax on the profits from the sale. Long-term capital gains tax is typically a lower capital gains rate than the tax rate for short-term capital gains, and depending on their taxable income, taxpayers will pay capital gains rates of 0%, 15%, or 20%.
Net Investment Income Tax (NIIT)
In addition to paying long-term or short-term capital gains tax, individuals who trade stocks who earn an income above a certain threshold are required to pay an additional net investment income tax of 3.8% because they are considered “high earners.” The income thresholds for paying this additional tax are $125,000 for people married filing separately, $200,000 for people who are single or head of household, and $250,000 for married filers or qualifying widow(er)s.
Dividends are the regular distribution of business profit paid out to investors who own a share of a company’s stock. Dividend distributions are usually paid out to shareholders every quarter or year, and because the IRS considers dividends a type of income, these earnings will be taxed accordingly.
Dividends are classified into two categories, depending on how long the stock is held, and the individual’s taxable income and filing status. These two categories are qualified and non-qualified dividends.
Ordinary dividends, also known as non-qualified dividends, are taxed at the same income tax rate as dictated by an individual’s personal income tax bracket. Some examples of dividend income that is considered non-qualified include:
- Dividend distributions paid on employee stock options
- Common stock dividends
- Special one-time dividends
- Dividend payments to shareholders by foreign businesses
- Dividend payments paid by certain U.S. companies, such as master limited partnerships or real estate investment trusts
Qualified dividends are those that are paid to shareholders at a tax rate of 0%, 15%, or 20% rather than the tax rates corresponding to their tax brackets. Additionally, to be considered a qualified dividend, the stock must be owned for a certain amount of time. Examples of qualified dividends include:
- Dividends paid by a U.S. company
- Dividends paid by a foreign country that trades or has a tax treaty with the U.S.
Taxes On Stocks Due Date
Similar to the way that federal income tax returns for a tax year are due on April 15 of the following year, taxes on stocks, including dividend tax and capital gains tax, are due on April 15 following the tax year that the stock was sold or a dividend payment was made.
However, this annual deadline for paying taxes on stocks only applies when a person is subject to income tax withholding. Taxpayers who do not experience tax withholding, such as self-employed individuals, freelancers, or entrepreneurs, are required to make quarterly estimated tax payments for capital gains and dividend tax.
The deadlines for quarterly estimated tax payments are approximately April 15, June 15, September 15, and January 15.
Tips For Saving Money With Stock Taxes
Individuals can employ certain tax savings strategies to help reduce their tax bill for stock taxes.
1. Deduct capital losses to offset capital gains.
If taxpayers experience a “net capital loss,” which is when their total capital losses exceed their total capital gains when they sell stocks, they have the option to claim a tax deduction of up to $1,500 from their ordinary income if they file separately, or $3,000 for married taxpayers.
2. Consider holding stocks for at least one year.
Holding stocks you have bought for 12 months or longer before selling them will qualify them for the long-term capital gains tax rate, which is significantly lower than the long-term capital gains tax rate. If holding onto assets for this time period aligns with your goals as an investor, this strategy can lower the cost impact of stock sales.
3. Hold shares in tax-advantaged accounts.
Holding shares inside a tax-advantaged account, such as an Individual Retirement Account (IRA) or a 401(k), is a beneficial strategy to lower expenses on taxes. Depending on the type of account, there are differences in the tax benefits. The capital gains and dividends for stocks held in accounts like a traditional IRA are tax-deferred, or those held in a Roth IRA are tax-free, which is different from typical brokerage accounts. As long as the taxpayer holds the money in their tax-advantaged accounts, they will not owe money on investment growth, interest, or dividends.
4. Hire a tax professional.
One of the most impactful strategies when trying to navigate taxes on stocks is to hire a tax advisor with thorough legal knowledge about tax topics and experience in navigating matters related to taxes for stock investors and traders.
Taxpayers can successfully lower their tax liability for investment income if they follow the advice of tax professionals and are strategic in their approach to being a trader in ever-changing stock markets.
If you are ready to learn more about the benefits of working alongside an experienced tax consultant and developing a tax strategy that results in maximum tax savings, schedule a free consultation with the analysts at Ideal Tax today. We specialize in various services such as tax audits, back taxes, tax lien withdrawal, tax relief, and more.