Let’s talk about stocks and taxes.
Today, we’ll be giving a complete overview on the subject – taxes on stocks.
We will be covering when you have to pay taxes on a stock, how to calculate how much taxes you have to pay on stocks, and how to lower your tax liability on stocks.
Even if you are new to stock investing or taxes, this post will be extremely easy to follow and understand.
When Do You Have to Pay Taxes On Stocks?
There are two ways you can be taxed on a stock:
1. The first way you may be taxed on a stock is if you sell a stock or security for a gain.
If you sell an investment that you held for less than a year, you will pay short-term capital gains tax.
The short-term capital gains tax rate equals your ordinary income tax rate – your tax bracket.
If you sell an investment that you held for more than a year, you will pay long-term capital gains tax.
The long-term capital gains tax rate is 0%, 15%, or 20% depending on your taxable income and filing status.
Here’s a look at both short-term and long-term capital gains tax rates depending on your tax bracket!
In short, in either scenario, if you end up with a profit from the sale of stocks at the end of the year, you will have to pay taxes on that profit.
This is also known as your capital gain.
2. The second way you may be taxed on stock is if the stock you hold pays dividends.
Dividends are payments made by companies to investors who hold their stock as sort of a bonus for holding.
An example of a company that pays dividends is CVS or Lowes.
There are two types of dividends- ordinary and qualified, and they are taxed differently.
- Ordinary dividends are taxed at your ordinary income tax rate- your tax bracket.
- Qualified dividends are taxed at a long-term capital gains rate which is 0%, 15%, or 20% depending on your taxable income and filing status.
Here’s how to know if your dividend is considered “qualified.”
– They must be paid by either a U.S. company, a qualified foreign corporation (one incorporated on U.S. soil or whose country signed an income tax treaty with the U.S.), or their shares must trade on an American exchange.
– They must not satisfy conditions the IRS lists as “dividends that are not qualified dividends,” which include capital gain distributions, dividends from tax-exempt corporations, and payments in lieu of dividends, to name a few.
– An investor must have held the stock for more than 60 days in the 121-day period that starts 60 days before the ex-dividend date.
Note that reinvested dividends are treated as if you actually received the cash, and taxed accordingly.
Now that we know the two ways you can be taxed on stocks, let’s discuss how to calculate how much taxes you have to pay on stocks.
How to Calculate Taxes You Have to Pay On Stocks
Here’s a simple four-step process:
1. Determine how much profit a.k.a capital gain you received from the sell of a stock.
2. Find out how long you held the stock before you sold it.
3. Determine how much capital gains tax you will have to pay. As mentioned previously, this will be determined by how long you held the stock and your tax bracket for the year.
4. Calculate your tax liability by multiplying your capital gain a.k.a profit by your appropriate capital tax gain rate.
Let’s walk through an example:
Let’s say, someone owned a stock for 366 days (more than a year) before he sold it for a gain of $3,000.
That covers steps 1 & 2 (determine profit ($3,000) and length of ownership (more than a year)).
Next, let’s say that he is in the 22% tax bracket.
From the information we know so far, we know that because he held the stock for longer than a year before he sold them, that he will pay a long-term capital gains tax of $3,000.
Because he is in the 22% tax bracket, we also know that his long-term capital gains tax rate is 15%.
Remember our formula: Capital gain x Capital gain tax rate
Let’s calculate our tax liability from this sell:
$3,000 (capital gain) X .15% (long-term capital gain tax rate) = $450 in taxes
Now that we know how to calculate how much taxes you have to pay on stocks, let’s discuss ways to lower your tax liability on stocks.
Ways to Lower Your Tax Liabilities on Stocks
1. The most obvious way is to hold your shares for longer than a year so you can take advantage of the long-term capital gains tax rate.
2. Another way to minimize your tax liability is to use your capital losses to offset your capital gains through a process called tax-loss harvesting.
In short, when it comes to capital gains from the sale of a stock, you can offset 100% of the loss to the gain.
If you don’t have any gains at all from the sale of stocks for the year, you can use up to $3,000 in losses to offset up to $3,000 of ordinary income for the year.
This changes to $1,500 if you’re married, filing separately.
3. In addition, you can choose qualified dividend stocks over ordinary dividend stocks
4. Furthermore, dividends and capital gains on stock held inside a traditional IRA are tax-deferred and tax-free if you have a Roth IRA.
That’s it – a complete overview of tax on stocks!
Simply click this link to get started today.