Taxes on Stocks Explained
2020 was a wild year for the stock market. Let us help you get up to speed on what you owe.
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You made a few bucks in the stock market last year, awesome!
You built up your portfolio, had a fancy dinner with some of the earnings, and showed off in front of your friends. Nice!
What’s next? Paying the government. 🤦♂️
The laws that dictate what we owe on our taxes are constantly changing. Even now, the Biden administration is eyeing a proposal that could raise capital gains tax by over 20%. That is a big chunk of change for investors, so it’s important to know what the rules are each year.
This is a big deal because paying too much taxes can slice away a huge chunk of your profits—if you don’t know a few tricks. Depending on how you plan your investments, you can end up paying much less to Uncle Sam than your fellow traders who don’t know how to use the legal benefits they have.
We’ve collected new information for the 2024 tax season to get you started. We will help you understand how stocks are taxed, what the difference is between short-term and long-term capital gains, and how much you will potentially owe this year.
Ready? Let’s get to it!
- How Stocks Are Taxed
- Short-Term Capital Gains Tax
- Long-Term Capital Gains Tax
- State Capital Gains Tax on Stocks
- How are Dividend Stocks Taxed?
- How to Pay Taxes on Stocks
- How to Pay Less Taxes on Stocks
- What About Losses with Stocks?
- When Do I Have to Pay?
- Capital Gains Tax Exceptions
How Stocks Are Taxed 💰
The IRS taxes individuals for earned and unearned income. Earned income comes from things like your wages, salary, or tips. Unearned income comes from the gains you make from the sale of stocks and even dividends you are paid. Yes, not even dividend investors will escape the Eye of Sauron that is the IRS. 😈
While some of the top stock brokers don’t charge investors commissions, taxes are unavoidable. Uncle Sam dipping into your profits can seriously suck, but the upside is the costs can be calculated and prepared for.
Stocks are going to be taxed based on the gains they generate. If you saw your holdings appreciate in 2020 and then sold them for more than you paid for them, that’s again; you will owe taxes on the profits.
Capital gains tax rates are categorized as either long-term or short-term. Generally, long-term investments are those that have been held longer than 365 days and they have a lower tax rate than earned income and short-term investments.
Short-Term Capital Gains Tax 💲
For those stocks that you bought and sold in under 365 days, you will be taxed at your ordinary-income rate. The short-term gains tax is going to be less favorable than the long-term rate in most cases. Some investors will favor different stock trading methods to avoid excessive tax liabilities.
Because short term gains are tied to income, and the income tax is a progressive tax, your earnings from stocks may push you to a higher bracket. Your filing status will affect the amount you owe as well as your income. The different filing brackets and categories are listed below, with the data from the IRS.
Individual Filers
| Taxable Income | Tax Rate |
|---|---|
| $0 - $9,875 | 10% |
| $9,876 - $40,125 | $987.50 + 12% for the the income above $9,875 |
| $40,126 - $85,525 | $4,617.50 + 22% for the the income above $40,125 |
| $85,526 - $163,300 | $14,605.50 + 24% for the the income above $85,525 |
| $163,301 - $207,350 | $33,271.50 + 32% for the the income above $163,300 |
| $207,351 - $518,400 | $47,367.50 + 35% for the the income above $207,350 |
| $518,401+ | $156,235 + 37% for the the income above $518,400 |
Filing Jointly
| Taxable Income | Tax Rate |
|---|---|
| $0 - $19,750 | 10% |
| $19,751 - $80,250 | $1,975 + 12% for the the income above $19,750 |
| $80,251 - $171,050 | $9,235 + 22% for the the income above $80,250 |
| $171,051 - $326,600 | $29,211 + 24% for the the income above $171,050 |
| $326,601 - $414,700 | $66,543 + 32% for the the income above $326,600 |
| $414,701 - $622,050 | $94,735 + 35% for the the income above $414,700 |
| $622,051+ | $167,307.50 + 37% for the the income above $622,050 |
Long-Term Capital Gains Tax 💷
Long-term capital gains come from realizing a gain more than a year from when you first bought an asset. Long-term capital gains taxes are a lot easier to account for than short-term taxes. These are either going to be 0%, 15%, or 20% depending on your taxable income, but those rates are bound to change each year.
Long-Term Capital Gains Tax Brackets
| Filer Status | 0% | 15% | 20% |
|---|---|---|---|
| Individual | $0 - $40,000 | $40,001 - $441,450 | $441,451+ |
| Head of the Household | $0 - $53,600 | $53,601 - $469,050 | $469,051+ |
| Married Couple Filing Together | $0 - $80,000 | $80,001 - $496,600 | $496,601+ |
| Married Couple Filing Separately | $0 - $40,000 | $40,001 - $441,450 | $441,451+ |
Long-Term vs. Short-Term Capital Gains Tax 📊
As you can see, the difference between the short-term and long-term capital gains tax can be significant. Let’s look at an example to understand what you will owe for different situations.
Let’s say that you are an individual filing singularly. You make $60,000 a year from your paycheck and you have bought $10,000 of a stock at $100 per share. The stock appreciated over time to $150 a share. How much will you owe if you realize your gains in the short-term or in the long-term?
| Purchased 100 shares for $100 | Sold 100 shares for $150 | Capital Gain |
|---|---|---|
| $10,000 | $15,000 | $5,000 |
The Short-Term Scenario 💸
You buy and sell the stock in a year or less. The $5,000 that you make will be added to your other earned income for the year. For an individual making $60,000, this will raise your taxable income to $65,000. This means you are in the 22% tax bracket and you will owe $1,200 for your gains.
| Capital Gain | Taxed at 22% | Total Profit |
|---|---|---|
| $5,000 | $1,200 | $3,800 |
You would walk away with $3,800 of your original $5,000 dollar return. This cost is significant and should be factored into your decision to realize any gains.
Something else that investors should consider is that it is possible for your capital gains to push you into a higher tax bracket. For example, if your income was $85,000 and your short-term gains added an additional $5,000 to your income. You would have made $90,000 for the year.
With an income of $90,000, an individual will have to pay taxes at the 24% tax rate. It’s important to consider how you can increase your overall profitability by waiting to realize your gains until a year after you purchased them.
For some traders, waiting to realize gains is antithetical to their strategy. If you are using the top day trading software, you will likely owe short-term gains each year you are trading.
The Long-Term Scenario 📈
If the same individual with the $60,000 income waits to realize their $5,000 gains until a year after they originally purchased the asset, the outcome will look different. Instead of the 22% tax bracket, the gains are going to be charged on the special capital gains tax rate. For individuals who make from $40,001 to $441,450 (probably most of us 😎), that’s going to be 15%.
| Capital Gain | Taxed at 22% | Total Profit |
|---|---|---|
| $5,000 | $750 | $4,250 |
Instead of paying $1,200, you only owe the government $750. This means you are saving $450 just for holding on to your asset for more than a year. It is often favorable to pay the long-term gains rate than the short-term gains rate. Investors can lower their cost liability even further by taking advantage of a high-quality discount brokerage.
Your trading strategy is integral to the type of tax that you pay. For many investors, you could end up paying one or the other, but potentially both in the same year.
State Capital Gains Tax on Stocks 🇺🇸
The federal government is going to take a bite out of your profits, but don’t think the taxes stop there. Depending on the state you live in, you’ll have to fork over more money.
Most states are going to tax you at the normal rate as your income for any money made from stock growth. There are 9 states that tax less for capital gains:
- ☑️ Arizona
- ☑️ Arkansas
- ☑️ Hawaii
- ☑️ Montana
- ☑️ New Mexico
- ☑️ North Dakota
- ☑️ South Carolina
- ☑️ Vermont
- ☑️ Wisconsin
Living in these states will give individuals some advantages over the regular income tax rate that almost all other states use. In a few more states, like Colorado, Idaho, or Louisiana, there are other tax incentives to reduce the burden on payers.
Different state taxes on capital gains range from 0% for some of the states mentioned above to 13.30% in California. The situation in each state can be dynamic; in the future, some taxpayers could be paying as much as 50% for their gains.
How are Dividend Stocks Taxed? 🧾
Dividend stocks may require a bit more mental gymnastics to figure out. 🤸♀️ You’re basically going to follow the same method that you followed for long-term and short-term gains. If you have a dividend-paying stock that has been paid for a certain period of time, known as the holding period, then that stock is a “qualified dividend.”
Qualified dividends are taxed at the same 0%, 15%, and 20% rate that you will pay for long-term capital gains. However, the holding period can be a little tricky to figure out.
To meet the holding period requirements, you must hold the stock for more than 60 days during the 121-day period that begins 60 days prior to the ex-dividend date. The ex-dividend date is the latest date a shareholder must hold stock to qualify for the dividend.
If you haven’t kept track of what dividends are qualified and which aren’t, don’t worry. Your stockbroker will provide you with the 1099-DIV form which will list what dividends are qualified and which aren’t.
If your dividends are not qualified dividends, then you will be taxed the same rate you are taxed for short-term capital gains. The money you made from dividends will be added to your earned income.
How to Pay Taxes on Stocks 👨🏫
Whether you are a long-time investor, or you are just picking your first brokerage, you will owe money for your capital gains. You will pay taxes on stocks when you file. There are a few tax documents that the IRS uses to calculate what you owe. These forms may include:
- ☑️ 1099 forms – 1099 forms are a record of people other than the employer that paid you.
- ☑️ State and local taxes
- ☑️ Educational expenses
- ☑️ Retirement account contributions
- ☑️ Property taxes and mortgage interest
- ☑️ The W-2 form – this document includes the wages and benefits that your employer paid you.
Most filers will either use the IRS 1040 form to file their own taxes or use an in-person or online tax accountant to figure out what they owe.
Once you calculate how much money you owe to the IRS, you will be able to transfer money to them via electronic payments and wire transfers. You can even use credit or debit cards. If you are unable to pay taxes all at once, you may have the ability to pay over time.
In some instances, you won’t owe the IRS any money. Maybe your employer took enough out of your check each month, and you made estimated tax payments. When you file your taxes, you’ll find the IRS owes you money.
How to Pay Less Taxes on Stocks (Legally) 💡
Paying less on taxes can be one of the easiest ways to increase the profitability of your stock trading income. As we’ve discussed already, long-term capital gains are often taxed at favorable rates as opposed to short-term gains, so if it is feasible to do so, wait to realize your gains until you have held the asset for longer than a year.
Nevertheless, it can be a good idea to continuously buy and sell stocks. After all, buying and selling stocks continuously is what allows day traders to leverage gains into more profits. Day traders often realize gains many times per day. Waiting for a year to go buy isn’t going to be the right solution for every trader.
An alternative to waiting to realize gains on your stocks is to use some of the money you lost on the stock market to offset gains. This is called tax-loss harvesting.
Tax-loss harvesting is when an investor sells an investment that has lost value in their portfolio and adds another stock. The investor uses the money they lost to offset any capital gains.
Besides tax-loss harvesting, taxpayers may be able to lower their liability by taking advantage of tax-exempt accounts. Some of the top brokers offer IRAs that allow you to defer tax payments.
What Happens When You Lose Money on Stocks 📉
We know what capital gains are, but what happens when you don’t come out on top of a trade? That is a capital loss.
If you bought a stock at $350 and saw the price plummet to $50 and then sold that stock, you would have a capital loss. Capital losses undercut your yearly gains and can be used to account for up to $3,00 of non-investment income.
As we’ve discussed, capital losses can be useful for offsetting your tax liability. You can subtract your capital losses from capital gains to find what you really owe the IRS. For example, if you realized $1,000 in profits from a stock trade, but then lost $950 on another trade, you will only owe money for the $50 profit.
When Do I Pay Taxes on Stocks? 📅
For 2021, the IRS began accepting tax returns on February 12th, but the deadline to pay isn’t until April 15th. Individuals can request an extension to file as late as October 15th. The IRS requires that brokers send the relevant 1099 tax documentation to tax-payers by February 15th.
If individuals do not file their tax returns by the due date or extended due date, they can be assessed a penalty of up to 25% of the total payment owed. If you need an extension to file, you will have to fill out IRS form 4868. It’s important for investors to complete this form to avoid unnecessary penalties.
Capital Gains Tax Exceptions 🔎
Investors may owe capital gains tax on a few items outside of stocks. These exceptions can range from collectibles to real estate, to jewelry. Tax liabilities can seep into every aspect of your financial portfolio. Keep in mind a few of the following situations.
Collectibles 💳
Gains from collectibles are taxed at 28% no matter what your income level is. This tax rate applies to objects from antiques to stamps.
Real Estate 🏦
Real estate investors will be able to write-off depreciation for their investments. There are different exemptions based on whether the real estate property is lived in by the property owner or rented out.
Small-Business Stock 🪙
There are special exemptions for small-business stock if the investor has held the stock for more than 5 years. These small business stocks will come from C corporations and have to have been acquired after 1993.
Taxes on Stocks FAQs
-
How Do I Avoid Paying Taxes on Stocks?
You can avoid paying excessive taxes on stocks by holding your assets for over a year. This means you are paying the long-term capital gains rate instead of being taxed at the earned income rate.
-
Does Selling Shares Count as Income?
No. As long as you sold the shares you own for more than the price you bought them at, this is not considered income, but a capital gain. However, dividend payments, in some cases, are considered income and are taxed as such.
-
Do You Only Pay Taxes on Stocks When You Sell?
You only pay taxes on realized gains. If you don’t sell a stock, you will not owe taxes for it. However, you may owe tax on any dividends you were paid.
-
How Can I Claim Stocks When Filing Taxes?
You can claim stocks on your tax by filing the information you receive from your broker with the IRS. Brokers give out digital trading reports that users can print out and use to file their taxes.
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