Stocks are a fantastic way to make passive income but can play a massive part in your end-of-year tax bill. As you buy and sell investments, you may be wondering how are stocks taxed?
Profits on stocks are assessed a capital gains tax. If you sell a stock after holding it for less than a year, it’s charged taxes at the short-term capital gains rate, those held longer than a year are charged taxes at the long-term capital gains rate.
This article takes a deeper look at how stocks are taxed, including taxes on dividends. Additionally, we look at a few strategies to avoid and minimize taxes on stocks.
What Are Capital Gains Taxes?
When you profit by selling a stock for a higher price than you paid for it, the profit is considered a capital gain. The government requires you to pay taxes on these gains.
Short-Term Capital Gains
If you hold a stock for a year or less, the stock is taxed using the short-term capital gains rate. Profits made from the sale of short-term assets are taxed at the same rate as your income.
As long as the sale of short-term stocks doesn’t put you into another tax bracket, you can expect to pay the same tax rate as you do for your day job. The 2022 income tax brackets can be found on the IRS website.
Long-Term Capital Gains
If you hold a stock for longer than a year and you sell it for a profit, then you get a tax break on those profits. Most taxpayers pay 15% on profits from stocks that fall under this category; however, the rate can vary based on your income. In 2022 the long-term capital gains brackets include:
|Rate||Single||Married, filing jointly||Married, filing separately||Head of Household|
|20%||$459,751 & up||$517,201 & up||$258,601 & up||$488,501 & up|
It’s important to note that you pay long-term capital gains taxes based on the bracket you fall in. For example, if you are a single tax filer and make $100,000 a year, then you pay 15% on long-term capital gains. You wouldn’t need to pay 20% on long-term capital until your make $459,751 or more.
High-Income Earns Pay Additional Taxes
Those taxpayers that qualify as high-income earners are required to pay an additional 3.8% net investment income tax (NIIT) on all profits made from the sale of stocks. In 2022, the thresholds for high-income earners include:
|Married filing jointly||$250,000|
|Married filing separately||$125,000|
|Head of Household||$200,000|
It’s important to note that The NIIT is charged regardless of whether it is a long-term or short-term gain.
Do I Have to Pay Taxes on Dividends?
If you’ve ever held a stock, you may have noticed that you receive a payout on a monthly, quarterly, or annual basis. This payout is referred to as a dividend and is a small portion of the company’s income paid to its shareholders.
Unfortunately, you have to pay taxes on dividends as well. Therefore, even if you don’t sell stocks in any given year, you may still owe taxes on dividend payouts. The tax rate for dividend payouts depends on how long you’ve held a stock and your income. Dividends fall into two categories:
- Qualified dividends – generally stocks that are held for at least 61 days of a 121 holding day period. These are taxed at the long-term capital gains rate.
- Non-qualified dividends – anything that doesn’t count as a qualified dividend. These are taxed at the short-term capital gains rate.
It can be difficult to determine if a dividend counts as qualified due to the IRS requirements being quite lengthy and detailed. However, the good news is that your brokerage is required to send you a Form 1099-DIV if you earn $10 or more on dividends. The Form-1099 DIV tells you if your dividends are qualified or not, taking any guesswork out of it.
How Do I Avoid Paying Taxes on Stocks?
Tired of hearing about all of the ways you are required to pay the government on your portfolio gains? Us too! The good news is that there are several strategies that you can use to avoid or limit the taxes you pay on stock gains. These include:
- Using a tax-advantaged account – certain accounts like retirement accounts or college savings accounts don’t require you to pay taxes on income (or gains) until you withdraw the money. In accounts like a Roth IRA, you don’t have to pay taxes on gains at all.
- Tax-loss harvesting – When you sell a stock for a profit, it’s a good idea to sell a different stock in your portfolio at a loss. You can use the loss of funds to offset some of the taxes you owe on the income made from the successful stock.
- Donate to charity – If you’re so good at investing that none of your stocks are at a loss, consider donating some stocks to charity. You can often deduct the full market value of the stock at the time of donation and avoid paying any taxes on the profits.
- Sell when you have a low income – Most people’s income varies year to year. If you find that you had a low-income year, this is the best time to sell. If you make under $41,675 in 2022, then you don’t have to pay any taxes on your gains!
While we haven’t covered all of the ways you can limit your taxes on stock sales, this is a great place to start looking at how these strategies apply to your tax situation.
How Do I Learn More About Taxes on Stocks?
If you are looking to learn more about taxes on stocks or just taxes in general, check back to our blog. We post weekly articles to give you helpful tips on understanding taxes and the best ways to avoid them.
If you’re looking for advice on your personal tax situation, contact us today! Our tax professionals provide individual tax advice for a fraction of what you would pay an accountant.