Congratulations — you’ve played your cards right and have earned a profit from the stock market. But like any other source of income, Uncle Sam wants his cut. Your newfound earnings may leave you with questions such as, “How are stocks taxed?” and “When do you have to pay taxes on stocks?” Use this guide to help you sort out your tax liabilities and maximize your investments.
How Are Stocks Taxed?
If you own stocks, you won’t actually pay taxes until you sell them for a profit. You may have to pay taxes on dividends, but this is a separate discussion from taxes on stocks directly. When you sell stocks at a profit, you must pay capital gains tax. The exact tax percentage rate will depend on how long you owned the asset prior to selling it.
Short-Term Capital Gains
If you owned the stock for less than a year before selling it for a gain, your profits are subject to short-term capital gains taxes. The tax rate for short-term capital gains is identical to your ordinary income tax rate.
Long-Term Capital Gains
If you own the stock for longer than a year, any profits you receive from its sale are subject to long-term capital gains. The good news is that long-term capital gains are typically taxed at a lower rate than short-term capital gains. Your exact rate will be 0%, 15%, or 20%, depending on your taxable income and filing status.
Do I Pay Taxes on Stocks I Don’t Sell?
You’ll only pay taxes on stocks once you sell them. Until then, you won’t pay any taxes on the stock itself, even if its price rises during the applicable tax year. However, any dividends you receive will be subject to tax, though in a different way from the sale of actual stock.
How Are Stock Dividends Taxed?
Investors often choose stock dividends because they offer a form of passive income. Just remember that these dividend payments are also subject to taxation. The actual tax rate depends on what type of dividends you receive: qualified or nonqualified. If you’re unsure which type of dividend you have earned, contact the company or your stock broker.
Nonqualified Dividends (Ordinary Dividends)
Nonqualified dividends are taxed at the same rate as your regular income bracket. This means that investors in higher income brackets will pay more in taxes for their dividend payments.
Qualified Dividends
Qualified dividends are taxed at a rate of 0%, 15%, or 20%, depending on your taxable income and filing status. This rate is usually lower than the tax rate for ordinary dividends.
How to Report Taxes on Stocks
When you sell stocks at a profit or loss, you must report the sale at some point during the current tax year. For instance, suppose that you sold a stock at the end of December of 2023. In that case, you would report the profit on your tax return by April 18, this year’s tax deadline. To report stocks and dividends on your tax return, you must follow a particular process.
How to Report Stocks on Your Income Tax
You won’t receive paperwork for each stock that you sell. Instead, your broker or brokerage account provider will send you IRS Form 1099-B by mid-February of the following tax year. This paperwork will help you calculate your total gains and losses from the prior tax year. You’ll then use this information to fill out Schedule D of Form 1099.
How to Report Dividends on Your Income Tax
Dividends are reported in a similar manner. You’ll use Form 1099-DIV to gain the necessary information regarding your dividend payments, which you will subsequently use to complete Form 1099.
Special Tax Scenarios for Stocks
Two unique tax scenarios are worth mentioning: net income investment tax and payment of taxes on stocks if you are self-employed.
Net Income Investment Tax (NIIT)
Certain high-income investors may be subject to an additional tax known as the net investment income tax (NIIT). The IRS imposes a 3.8% tax on either your net investment income or your modified adjusted gross income if it exceeds one of the following income thresholds:
- $250,000 (if you’re married and filing jointly)
- $125,000 (if you’re married and filing separately)
- $200,000 (single filers and heads of household)
NIIT applies to individuals, estates, and trusts. In addition, the tax will apply to either your investment income or modified adjusted gross income, whichever is highest.
Paying Taxes on Stocks if You’re Self-Employed
If you’re self-employed, you may already be paying quarterly estimated tax payments. Should you sell stocks during the tax year, you’ll pay the capital gains tax at the next due date instead of splitting the income up across your tax year.
Later, you can report your capital gains on your income tax return using the steps above. However, by paying ahead of time, you can minimize your financial burden once you’re ready to file.
Playing the Stock Market Game and Lowering Your Tax Liability
Is it possible to reduce the amount of money you owe in taxes due to the sale of stocks? The following tips can help you lower your tax liability, allowing you to keep more of the money you earn from your investments.
Play the Long Game
If you’ve been paying attention, you have likely discovered that long-term capital gains taxes tend to be lower than your regular income tax rate. But in order for the sale of stocks to be counted as long-term capital gains, you must own the asset for over a year. Delaying the sale of your stocks until after a year or more can lower your tax burden.
Similarly, it’s possible to hold onto dividend stocks for long enough that your dividends are classified as qualified. This will also reduce the tax rate that applies to this income.
Use Losses to Offset Gains
Capital gains taxes only apply to your net capital gains — not your gross earnings. If you sell another asset at a loss, you can use this loss to offset the money you earned from the sale of a high-performing stock.
For instance, imagine that you sell your shares of Company XYZ for a profit of $10,000 but sell your shares of Company ABC at a $2,000 loss during the same tax year. When it’s time to pay taxes, you’ll only owe capital gains on $8,000, the net gains after subtracting your loss.
Donate Stocks to Charity
You can donate appreciated stocks to charity rather than sell them outright. While you won’t get the value of the stock from the sale, you can legally deduct the fair market value of the stock shares from your income. You’ll also be supporting a worthy, local cause in the process.
Use a Tax-Advantaged Account
Any capital gains and dividends from stocks held in a traditional IRA are tax-deferred, and they’re tax-free when held in a Roth IRA. A 401(k) is also tax-advantaged in that you won’t pay taxes on investment growth as long as the money stays within your account.
Just be aware that these accounts come with contribution limits, so they may not be an ideal choice for managing your entire portfolio. Still, investors may rely on these sorts of accounts for high-return investments or stocks that they plan to trade more frequently.
Get Bigger Gains
Of course, your tax rate is of secondary importance to the actual gains you receive from the market itself. Gorilla Trades aims to be an all-inclusive platform to help you reach your investing potential. Sign up today for a free trial. You’ll enjoy 30 days of free stock picks, which are just a sample of the robust resources our members have access to.