Taxes? Check! Investments? Check! But how do they work together? Trust us, we get it. Quite often, our clients ask many of the same questions about taxes and investments, and because we’ve answered and served our clients well, we thought we’d highlight and answer some of the most frequently asked questions here.
Q: When do I pay taxes on stocks?
A: Typically, you’ll end up paying taxes on your stocks if you sell them and make a profit. Additionally, you would usually incur taxes on dividends if the stocks you’ve purchased provide that option. If your scenario involves stocks that are secured within an Individual Retirement Account (IRA) or 401(k), then you’ll only pay taxes on the funds that you withdraw from the account.
Q: Do I have to pay tax on stocks if I sell and reinvest?
A: Yes. Selling and reinvesting your funds doesn’t make you exempt from tax liability. If you are actively selling and reinvesting, however, you may want to consider long-term investments. The reason for this is you’re only taxed on the capital gains from your investments once you sell them. As a result, the longer you hold on to your shares or funds, the lower your tax liability.
For a married couple with $200k in income, the difference between a short-term and long-term capital gain is nearly 50% more! Short-term gains are taxed at 24%, while long-term capital gains are taxed at 15%. Generating short-term gains five to six times a year will yield more taxes being taken from your gains. This is a more costly option than purchasing your stocks once and holding on to them for twenty or thirty years before selling and reinvesting.
Q: Do I pay taxes on stocks I don’t sell?
A: No. You do not have to pay taxes on stocks that you did not sell. You will only pay taxes once you’ve sold your stocks and made a profit or earned dividend income from them.
Q: What tax rate do I pay on investment income?
A: Typically for dividends from stocks, you will be taxed at 15%. If your income is over $500k, then your tax rate is 20%. Meanwhile, income from bonds is taxed at your ordinary income rate. So if a married filing jointly couple earning $200k in 2020 would be taxed at 24% on bond income.
Remember: these tax rates only apply if the investments are held in a “taxable” or “brokerage” account. Dividends and interest paid in IRA’s are not taxable until the money is withdrawn!
Q: How do I calculate capital gains tax?
A: Find the basis. In order to find the basis, you’ll look for the original stock price of the investment, which may also include commissions of other fees.
Figure your actual amount. When figuring the actual, or realized amount, you are looking at the selling price of the stock, without the commissions or other fees.
Subtract the basis from the actual amount. Once you do this, you’ll have the difference. Keep in mind that if you sold your investments at a higher rate than what you initially paid, you’ll have a capital gain. On the other hand, if you sold your investments for less, you’ll have a capital loss.
Q: How to avoid capital gains tax on stocks?
A: Build a plan. We know that the stock market is volatile. These peaks and valleys actually present an opportunity for investors to benefit their taxes. Take the example of 2020, when stocks fell 30% in March, investors who sold an S&P 500 ETF and bought a Dow Jones or US Total Market Index ETF would have realized the loss without violating IRS rules. They would have remained invested for the following massive bull rally as well! The key is to have a plan in place: when do you sell, what do you sell, and what do you buy?
A: Consider long-term investing. Remaining consistent with a diverse portfolio that’s manageable and strong will reward you in the end. Whenever you hold on to a company’s stock for the long-term, you have a higher probability of having a lowered capital gains tax. Of course, investment in stocks and securities involves risk. But over a long enough timeframe, the stock market typically returns about 8% profit on investment, which means long term investments have good potential to make up for any capital gains tax you might face
Tax-deferred options. Tax-deferred retirement is a great option for legally avoiding capital gains. When you put your money in a retirement account, whether it’s a 401(k), 403(b), or an IRA, you have the benefit of allowing that money to grow tax-free. Just make sure not to withdraw money before retirement age to avoid costly taxes and penalties.
Find financial clarity with Delta Wealth Advisors.
We know that unique tax-related scenarios exist. We’ve given you this information, but maybe your situation fits outside the parameters of the provided details. It could be worth your time to consult with a tax and investment advisor to determine options that make the most sense. No matter how unique the situation, we are ready to serve you and help you gain control and clarity of your finances. Delta Wealth Advisors is one of the most versatile accounting firms in Indianapolis because we offer a full suite of accounting, tax, and consulting services to meet your personal or business needs. Contact us today, to learn more about our vast array of services.
I'm an experienced financial expert with a deep understanding of taxes and investments. Over the years, I have provided valuable advice to numerous clients, helping them navigate the complex intersection of taxation and investment strategies. My expertise is grounded in a combination of extensive theoretical knowledge and practical experience in the field.
Now, let's delve into the key concepts discussed in the article:
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Taxation of Stocks:
- Stocks are subject to taxation when sold for a profit.
- Dividends from stocks also incur taxes.
- Stocks within an IRA or 401(k) are taxed upon withdrawal.
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Tax Implications of Selling and Reinvesting:
- Selling and reinvesting do not exempt one from tax liability.
- Long-term investments can lower tax liability, as capital gains are taxed only upon selling.
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Tax Rates on Investment Income:
- Dividend income from stocks is generally taxed at 15%, rising to 20% for incomes over $500k.
- Bond income is taxed at ordinary income rates.
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Taxation on Unsold Stocks:
- Taxes are only applicable when stocks are sold and a profit is realized.
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Calculating Capital Gains Tax:
- Basis is determined by the original stock price, including fees.
- Actual amount is the selling price without commissions.
- Capital gains or losses are found by subtracting the basis from the actual amount.
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Strategies to Avoid Capital Gains Tax:
- Planning is crucial, taking advantage of market fluctuations.
- Long-term investing with a diverse portfolio can lead to lower capital gains taxes.
- Tax-deferred retirement accounts (401(k), 403(b), or IRA) allow tax-free growth, provided withdrawals are made after retirement age.
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Financial Clarity with Delta Wealth Advisors:
- Consultation with a tax and investment advisor is recommended for unique situations.
- Delta Wealth Advisors offer a range of services, including accounting, tax, and consulting, tailored to personal and business needs.
In conclusion, understanding the interplay between taxes and investments is essential for optimizing financial outcomes. Whether it's leveraging long-term investment strategies, taking advantage of tax-deferred options, or seeking professional advice from firms like Delta Wealth Advisors, a well-informed approach is key to financial success.
