If you’re wondering how stocks are taxed and what the stock tax rate might be, we’ve got you covered.
Capital gains taxes are taxes imposed on profits made from the sale of certain assets, including investing in stocks, bonds, real estate, or other investments. These taxes are calculated based on the difference between the purchase price (cost basis) and the selling price of the asset. If the selling price is higher than the purchase price, a capital gain is realized. If lower, a capital loss is incurred. Individuals with brokerage accounts are directly affected by capital gains taxes when they buy and sell securities in their accounts. Selling a stock for a profit yields a capital gain.
Capital gains tax rates depend on the holding period of the investment, which is categorized as either short or long-term. Assets held for one year or less are subject to short-term capital gains. Alternatively, assets held for more than one year fall under the category of long-term capital gains.
How much in taxes do you have to pay on stocks? In most cases, short-term capital gains are taxed at your standard income tax rate — the same tax rates that apply to your regular income. These stock tax rates vary depending on an individual's income level and tax bracket. For example, if you fall into the 25% tax bracket for ordinary income, your short-term capital gains would also be taxed at 25%.
Long-term capital gains have lower tax rates than short-term gains. Long-term capital gains tax rates are structured as follows:
Federal long-term capital gains tax rate
Single filer income
Married, filing jointly income
Less than or equal to $41,675
Less than or equal to $83,350
Greater than $41,675 but less than or equal to $459,750
Greater than $83,350 but less than or equal to $571,200
Greater than $459,750
Greater than $571,200
Note these rates can change, so always check with a tax professional for the most up-to-date information.
In addition to federal capital gains taxes, most states charge a tax on capital gains between 2.9% to 13.3%. The only states that do not charge tax on capital gains are:
Owning stocks themselves does not trigger a tax liability. The tax event occurs at the time of sale when you realize the gain or loss on your investment. The tax liability arises when you sell stocks for a profit, regardless of whether you plan to reinvest the proceeds or hold the funds in your brokerage account. You’re required to report any capital gains or losses on your tax return for the applicable tax year.
While owning the stock does not generate a tax liability, if the stock pays a dividend, receiving those dividends will. A dividend is a payment disbursed by a company to its shareholders, serving as a means of distributing its profits. When a company earns profits, it can choose to reinvest them back into the business or distribute them to its shareholders in the form of dividends. Dividends are usually paid in cash, but they can also be issued as additional shares of stock or other property.
The specific tax treatment for dividends in the United States depends on how they’re classified: either qualified or non-qualified. Qualified dividends are subject to a lower tax rate because they meet certain requirements set by the Internal Revenue Service (IRS). To qualify, the dividends must be paid by a U.S. corporation or a qualifying foreign corporation, and the shareholder must hold the stock for a specified holding period, generally more than 60 days during the 121-day period that begins 60 days before the ex-dividend date, which is when the date when the stock starts trading without the dividend.
Non-qualified dividends, also known as ordinary dividends, do not meet the criteria for qualified dividends. Hence, they’re generally taxed at the shareholder's ordinary income tax rates, which are typically higher than the tax rates for qualified dividends.
Do you have to pay taxes on stocks? As we’ve seen from the prior section, if you profit from the sale, the answer is yes. Nonetheless, here are several strategies you can employ potentially to lower taxes on stocks listed below.
Holding stocks for the long term. By holding stocks for more than one year, you can qualify for the lower long-term capital gains tax rates. This approach allows you to pay a lower tax rate when you eventually sell your stocks.
Utilizing tax-efficient investments. Certain investments, such as index funds or tax-managed funds, are structured to minimize taxable distributions, which can help reduce your tax liability. These funds aim to minimize buying and selling within the fund, which can trigger capital gains.
Tax-loss harvesting. If you have investments that have declined in value, you can sell them to realize a capital loss; offsetting capital gains you may have realized from other investments, potentially lowering your overall tax liability. However, it's important to be aware of the IRS's wash-sale rule, which disallows the recognition of losses if substantially identical securities are repurchased within 30 days.
Maximizing contributions to tax-advantaged accounts. Contributing to tax-advantaged accounts, such as individual retirement accounts (IRAs) or 401(k) plans, can provide tax benefits. Traditional IRAs and 401(k) plans offer tax-deferred growth, meaning you won't owe taxes on capital gains and dividends within the account until you make withdrawals in retirement. Roth IRAs and Roth 401(k) plans, while not providing immediate tax deductions, offer tax-free growth and tax-free qualified withdrawals in retirement.
Charitable donations. Donating appreciated stocks to qualified charities can be a tax-efficient strategy. You can generally deduct the fair market value of the donated stocks from your taxable income, and you can avoid paying taxes on the capital gains of those stocks.
When you sell your stocks for a profit, do you have to report those stock sales on your taxes? The answer is yes, and you’ll need to use IRS Form 8949, "Sales and Other Dispositions of Capital Assets." This form is used to report the details of each individual stock sale transaction, including the date of sale, proceeds from the sale, cost basis, and any resulting gain or loss.
To obtain IRS Form 8949, you can either:
Download it from the IRS website. You can access the form directly from the IRS website at www.irs.gov. Search for "Form 8949" in the search bar, and you should be able to find the current version of the form in PDF format.
Tax preparation software. If you’re using tax preparation software to file your taxes, the software will typically provide you with the necessary forms, including Form 8949. The software will guide you through the process of inputting your stock sale transactions and generating the form.
A 1099 B form is typically provided by your brokerage or financial institution on an annual basis for tax purposes. It summarizes the proceeds from your stock sales, along with the cost basis information, and is sent to you and the IRS. However, there are cases where you may not receive the form from your brokerage, such as if you had a limited number of transactions or if the transactions were not reportable.
In such situations, you are still responsible for accurately reporting your stock sales to the IRS. You can gather the necessary information from your own records, including trade confirmations or account statements provided by your brokerage. The key details you need for each stock sale are the date of sale, proceeds from the sale, and the cost basis.
When you sell a stock for profit, you generate a capital gain which in turn triggers a tax liability. The amount of the liability will depend on whether the gain is short- or long-term, with different tax rates for both. If the stock pays a dividend, that will also incur a tax liability whose amount will depend on whether the dividend is considered qualified or not.
If all this still seems complicated, or you’d like to understand how to manage your tax liabilities better, seek the assistance of a skilled professional. Let FinanceHQ find the right advisor to help you navigate the nuances of taxes on stocks as they pertain to your unique situation.
Amanda brings 30 years of experience in banking and finance.