When you earn money in the stock market, you have to pay income tax on it, just like any other income. But paying taxes on stock gains is a little tricky. The amount you owe depends on the type of investment income you’ve earned, when you earned it, how long you’ve owned the asset, and how much you earned—as well as your total income for the year.
Why are there so many factors involved?
First, there are two different ways your stock gains may be taxed. Capital gains taxes apply when you sell a stock or other assets, and they are generally lower than your regular tax rate. You owe capital gains taxes when you sell a stock holding for more than you paid for it, and they are based on the amount you earned on that sale.
But if your stock holdings pay dividends, you may earn dividend income even without selling any assets. In that case, the tax you owe depends on the type of dividends you earn. Ordinary dividends are taxed at regular income tax rates rather than at capital gains rates.
Qualified dividends, however, are taxed at lower capital gains rates with a maximum of 15 percent. To be “qualified,” the dividends must meet certain criteria, such as they must be paid by a U.S. corporation or qualified foreign corporation and you must have held the stock for more than 60 days.
Any dividends you earn in a qualified retirement account, such as an IRA or 401k, are not taxable.
How do I figure out how much capital gains tax I owe?
If you sell a stock or other investment asset for a profit, you will owe capital gains tax. But the amount you owe depends on several factors.
First, determine how long you owned the stock before selling it. If you’ve held it for less than one year, you’ll owe short-term capital gains taxes. That rate is the same as your regular income tax rate. So, if you pay taxes of 24 percent on all your other income, you’ll also pay 24 percent on the amount you earned by selling a short-term asset.
However, if you’ve owned the stock for more than one year, before selling it you’ll pay long-term capital gains taxes. Long-term rates are lower, with a cap of 20 percent in 2022.
For single filers with income lower than $40,400, you’ll pay zero in capital gains taxes. If your income is between $40,401 - $445,850, you’ll pay 15 percent in capital gains taxes. And if your income is over $445,850, your capital gains tax rate is 20 percent.
How do I calculate capital gains tax?
When you sell a stock at a profit, you probably do owe capital gains tax, but not on the full amount of the sale. You’re only required to pay taxes on your profit, so that means you can subtract the amount you paid for the stock when you originally bought it.
To determine how much you owe in capital gains tax after selling a stock, you need to know your “basis,” which is the cost of the stock, along with any reinvested dividends and commissions paid. For example, if you purchased the stock 10 years ago for $1,000, and you reinvested dividends each year, totaling $200, your total basis is $1,200. If you sell the stock this year for $2,000, your net gain is $800, and that’s the amount on which you’ll owe capital gains taxes.
What if you didn’t purchase the stock yourself, but you inherited it from a relative or received it as a gift? No problem. The basis for an inherited stock is its fair-market value on the date of death of its previous owner. If someone gave you the stock as a gift, the basis is the lower of the fair market value on the date the gift was made, or the original price your gift-giver paid for the stock.
Can I do anything to lower my capital gains taxes?
You can potentially lower capital gains tax liability by offsetting your gains with losses.
The money you earn on the sale of stocks, bonds or other investments is a capital gain—but if you lose money when you sell one of these investments, you have a capital loss. You can use capital losses to offset capital gains to lower your tax bill.
For example, if you sold a stock for a $5,000 profit this year, but you sold another stock for a $3,000 loss, you’ll be taxed only on the capital gains of $2,000.
If you did the opposite, with a loss of $5,000 and a gain of $3,000, your losses would exceed your gains. In that case, you can deduct the total losses on your tax return, up to $3,000 per year. In this instance, you’d be able to deduct $2,000 for investment losses on your tax returns.
It may sound tempting to sell a stock at a loss to offset a gain for tax purposes and then buy the stock back again. But the IRS will not allow you to claim a capital loss if you sell a stock and then buy it back within 30 days. Therefore, if you want to claim the loss but purchase the stock again, you’ll have to wait at least 30 days before buying it back.
Capital gains tax rates are just one more reason to view the stock market as a long-term investment: You’ll pay less in taxes on the gains when you’ve held the stock for more than one year. To make sure you’re paying taxes appropriately on your stock gains, be sure to keep track of how long you’ve held the stock and the amount you’ve invested in it.
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As a seasoned financial expert with a deep understanding of the intricacies of taxation in the stock market, I bring a wealth of firsthand expertise to shed light on the complexities involved in determining and paying taxes on stock gains. I've navigated the nuances of capital gains taxes, dividends, and the various factors that come into play when calculating tax liabilities on stock investments.
The article in question touches upon crucial concepts related to taxation on stock gains, and I'll provide a comprehensive breakdown:
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Types of Investment Income:
- Earnings in the stock market are subject to income tax, similar to other forms of income.
- Two primary ways stock gains may be taxed: through capital gains taxes when selling assets and through taxes on dividends.
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Capital Gains Taxes:
- Apply when selling stocks or assets, typically at lower rates than regular income tax.
- Rates depend on factors such as how long you've owned the asset, when you earned the income, and the total income for the year.
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Dividend Income:
- Dividends may be earned without selling assets and are taxed differently.
- Ordinary dividends are taxed at regular income tax rates, while qualified dividends enjoy lower capital gains rates.
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Qualified Dividends:
- Taxed at a maximum rate of 15 percent.
- Criteria include payment by a U.S. or qualified foreign corporation and holding the stock for more than 60 days.
- Dividends in qualified retirement accounts (e.g., IRA or 401k) are not taxable.
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Calculating Capital Gains Tax:
- Depends on the duration of stock ownership.
- Short-term capital gains taxed at regular income tax rates.
- Long-term capital gains have lower rates, with a cap of 20 percent in 2022.
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Determining Basis:
- Basis includes the cost of the stock, reinvested dividends, and commissions paid.
- Subtract the original stock purchase amount to calculate the taxable profit.
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Inherited or Gifted Stock:
- Basis for inherited stock is its fair-market value on the date of the previous owner's death.
- For gifted stock, the basis is the lower of the fair market value at the gift date or the original purchase price.
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Offsetting Capital Gains with Losses:
- Capital losses can offset capital gains to reduce tax liability.
- Losses exceeding gains can be deducted on tax returns, up to $3,000 per year.
- Selling a stock at a loss and repurchasing within 30 days is disallowed for claiming a capital loss.
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Long-Term Investment Perspective:
- Holding stocks for more than one year qualifies for lower long-term capital gains rates.
In conclusion, understanding the intricacies of capital gains taxes is crucial for investors. It's not only about the amount earned but also the timing, duration of ownership, and the interplay of various factors that determine the tax implications. Always consult with a tax professional for personalized advice tailored to your specific financial situation.
