As an investor, you spend a lot of time carefully researching and planning your investments. Play your cards right, and you stand to generate significant profits from your stock portfolio. But like any income you receive, you’ll have to pay taxes. How are stocks taxed? Our quick guide will explain stock market taxation guidelines so you can maximize your assets while complying with tax law.
What Is Capital Gains Tax?
When you sell an asset such as stocks, real estate, or other valuables, the profits you receive are known as “capital gains.” Calculating your net capital gains in the stock market is quite simple: you simply subtract your sale price from the purchase price to determine your profit.
Historically, the IRS did not make a functional distinction between short-term and long-term capital gains, meaning that all profits were taxed at your ordinary tax rate. This changed in 2018 with the Tax Cuts and Jobs Act (TCJA), which distinguished between short-term and long-term capital gains and introduced unique tax brackets for long-term capital gains.
Short-Term Capital Gains Tax
If you’ve owned your stocks for less than a year, then any profits you receive are taxed at your regular tax rate. Currently, taxpayers fall into one of seven different IRS tax brackets, whose tax rates range from 0% to 37%. Day traders and swing traders should be especially mindful of short-term capital gains taxes, since these strategies hinge on stock trades made in a short amount of time.
Long-Term Capital Gains Tax
Long-term capital gains tax rates can actually be a bit lower, which may provide incentive for stock market investors to play the long game. Long-term capital gains are taxed at either 0%, 15%, or 20%. The exact rate will depend on two critical factors: your filing status, and the amount of profit you earn.
How Are Stocks Taxed?: Dividends
Some companies distribute a portion of their profits to their shareholders in the form of dividends. This income is also taxable. The IRS identifies two kinds of dividends. Nonqualified dividends (sometimes called “ordinary dividends”) are taxed at your ordinary tax rate. Qualified dividends are taxed at 0%, 15%, or 20%, depending on your filing status as well as your total taxable income. Dividends must meet very strict criteria by the IRS in order to be considered “qualified,” and those that fail to meet these criteria will be taxed at your ordinary tax rate.
Stock Market Taxation Guide
How do you know what tax bracket you fall into? The exact tax bracket you fall into depends on your filing status as well as the income you generate. Below, we’ll provide a quick guide to help you find the tax bracket you might fall into if you are subject to a long-term capital gains tax or receive income from qualified dividends. Simply locate your filing status, and your tax bracket will be based on your total taxable income.
Unmarried adults fall into the following tax brackets based on the amount they receive from capital gains or dividends:
- Up to $40,000: 0%
- $40,001 to $445,850: 15%
- Over $445,850: 20%
Since “single” can apply to those who have been divorced or widowed, this category may be relevant to those who sell their stocks during their retirement years after losing or separating from a spouse.
Head of Household
Head of Household (HOH) generally refers to those who are unmarried but have dependents and/or live-in relatives, and pay more than half of the household expenses. These individuals fall into the following brackets:
- Up to $54,100: 0%
- $54,101 to $473,750: 15%
- Over $473,750: 20%
CNBC reports that taxpayers who file as “head of household” are entitled to a 50% larger standard deduction than those filing as “single,” making this a valuable strategy for those who meet the filing criteria.
Married Filing Jointly
Married couples see a substantial jump in the range associated with each tax bracket:
- Up to $80,800: 0%
- $80,801 to $501,600: 15%
- $501,600: 20%
This is in addition to the already-existing tax breaks associated with married couples who file jointly, making it advantageous to file with a spouse.
Married Filing Separately
Married couples will see the most advantages if they file jointly, but there may be a few circumstances in which it makes sense to file separately, such as if you want to take advantage of credits and deductions or one spouse carries a large amount of debt. These individuals will fall into the following brackets:
- Up to $40,400: 0%
- $40,001 to $250,800: 15%
- Over $250,801: 20%
Note that this filing status offers the least benefit, so it’s important to file separately only if other debts and deductions outweigh the benefits of filing jointly.
How Can I Reduce My Tax Debt?
Savvy investors should look for ways to reduce their overall tax debt. There are three general strategies you might consider in order to minimize your annual tax payments.
Play the Long Game
As we saw, long-term capital gains tend to get taxed at a lower rate than their short-term counterparts. Holding onto your assets for over a year can classify them as long-term gains, which could place you in a lower tax bracket.
Offset Gains with Investment Capital Losses
Your “net capital gain” is the difference between your capital gains and capital losses. Sometimes, your losses will exceed your gains. When that happens, you can deduct the difference on your tax return, as much as $3,000 annually.
Rely on a Tax-Advantaged Account
Some investment accounts offer tax advantages. A traditional IRA for example, will allow you to collect dividends and capital gains on a tax-deferred basis, and a Roth IRA will be tax-free. You also won’t pay taxes on any growth that comes from a 401(k), so long as you keep the money in your account.
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