How Are Taxes on Stocks Imposed and How Taxes Can Impact Your Stock Investment?

Tax obligations are imposed on everyone, and when you invest in securities, you are bound to pay capital gains tax. Investing in stocks is a good way of creating wealth over time, but the government will require you to pay out taxes just like in any other investment. Before you invest in stocks, it is advisable to talk to your financial advisor regarding your stocks and taxes. If you have invested in stocks, this article will guide you on how taxes on stocks are imposed and how they can affect your investments.

What is Capital Gain Taxes on Stocks?

Let’s say, if you have sold your shares of stocks at profit during the year, that is the only time you are liable for taxation. If you haven’t sold your shares, therefore, you do not have any reportable tax gain or liable to any due taxes.  You can own shares to a certain stock for several years without paying the taxes on stocks because the shares have not been sold yet.

What is Capital Gain Tax?

Selling your investments such as stocks, shares, mutual funds, bonds and other securities at a profit is what is referred to as capital gain. Therefore, you need to be accountable of your profits and pay tax on your capital gain. A simple formula for establishing the capital gain is: Capital Gain = Selling Price - Purchase Price. The government wants a cut of your profits from the sale of your stocks.

You should understand that there is a difference between the realized and the unrealized gains. A gain has not been realized if the appreciated investment has not been sold. For instance, if you bought stocks of a particular company a year ago, and it’s now worth 20% more than the purchase price. Your investment has appreciated, but because you have not sold it, you do not have any gains, nor do you have any tax liability.

Long-Term and Short-Term Capital Gain

Capital gain is categorized into two: the long-term and the short-term gains. Before you think of selling your stocks, you should understand the taxes on stocks based on the short-term and long-term basis.

Short-term gain is the profit you have gained from selling a property that you have held for less than a year. The ordinary income tax applies to the short-term capital gain, and it is usually high compared to the long-term gain.

The Long-term gains are profits that you have earned from an investment that you have held for more than one year. It is taxed using the long-term capital gains rates. The long-term capital gain tax rate range from 0%, 15% or 20% which depends on your filing status and taxable income.

How To Lower Your Taxes on Stocks

Generally, the long-term capital gains have tax advantage over the short-term ones. You can minimize your tax capital gain tax bill by holding your investment for at least more than a year before you sell them. To help you keep track of your investment, your broker app should help you to follow up and keep you from selling the stocks before the lapse of one year.

However, you can still sell your shares on short-term gains. If you are making good money in the short-term, ensure to set aside the taxes as you go by. Here are more tips to help you pay lower taxes on stocks:
1. Offset the Gains With Losses

Selling your stocks for less value than you paid, the incurred losses can help you to offset the taxable gains.

2. Invest Your Money in the College Savings or Retirement, or Any Other Tax Advantage Account

The funds that you deposit in savings accounts such as the traditional IRA are tax-deferred. The dividends and gains held in a Roth IRA account are not taxable. Also, the fund on 401(K) account are not taxed until you withdraw the money. This means, you are not taxed even if your money or investment earns an interest, grows, earn dividends, or the investment gains as long as the money stays in the account.

You can convert your traditional IRA account to Roth IRA so that you can withdraw your retirement funds which is tax-free. However, you should note that only taxed money is deposited on Roth IRA account. The backdoor Roth works best for people who are in the higher tax category during retirement as compared to now.

The profitable trades you make in the account are not taxed. Also, money in Roth IRA and educational accounts is not taxed as long as the funds are used within qualified expenses. If you want to lower the amount of taxes on stocks, you should consider buying or selling the stocks within the 529 educational plan or 401K retirement plan.

3. Sell Your Stocks When You Have a Low Income

Another strategy that allows you pay minimal taxes on your stocks is by selling your profitable stocks when you have a lower income either due to retirement or other valid factors. Note, when your income as a single person is less than $40,400 and less than $80,800 for married people, the long-term capital gain is zero.

How Are Capital Losses Handled?

When the stocks are sold at a loss, the results are a capital loss which can be used to offset gains from selling other stocks. The capital losses are also divided into both long-term and short-term gains using the one-year cut-off period.

The long-term losses go against the long-term gains. On the other hand, short-term losses offset the short term gains. The left over losses are used against other gains. Where the total losses exceed the gains of $3,000 in capital losses, it can be used to offset the income in any one year.

The Taxes on the Dividends

Dividends are taxable types of income. There are two types of dividends: the qualified and non-qualified. The non-qualified dividends are also known as the ordinary dividend. It has similar tax rate as that of the normal tax rate bracket.

The qualified dividends are the most preferred because they have a lower tax rate compared to non-qualified dividends. The tax rate for qualified dividends ranges from 0%, 15% or 20%, depending with your filing and income status.

More Tax Information You Should Know

The State Taxes- it is important to check the tax information of your state on capital gains. Different states have different taxation rates.

The Quarterly Tax Estimates- if your capital gains are going to increase your tax liability by more than $1,000, consider paying quarterly estimate tax payments on capital gains you have earned throughout the year. In the US, the quarterly payments for 2021 are paid on the following dates: April 15, 2021, June 15, 2021, September 15, 2021, and January 18, 2022. To calculate your tax liability, consult your financial advisor or check the IRS Form 1040-ES.

Also, if you just do a few trades in a year and you do not know how much tax you should pay, your financial advisor, will help you with the information. The financial advisor can help you come up with a tax strategy on your profits from your stocks and deal with your taxes on time.

Conclusion

Earning profits from your stock investment feels good. However, the taxation part can be such a pain. To avoid get cornered by the taxes, you should have the requisite information about taxes on stock investments. When you understand the aspect of taxes on the stocks, you can sit and enjoy the profits without wondering about the tax liabilities. Also, you should set aside the taxes on the gains as you go, to avoid getting overburdened at the end. Involve your tax advisor every step of the way.

FAQ

1. How is taxation done on stocks?

If you have shares in an ordinary brokerage account, you are required to pay the capital gains tax when you sell the shares at a profit. There are two types of capital gains tax, the short term and the long term. The rates that apply for the long-term capital gains tax are 0%, 15% or 20% which is based on your taxable income.

2. How to Pay Taxes for Having Stocks?

You cannot pay the taxes on stocks if you only bought them and you have not sold them. You are only taxed when you sell your shares. Also, you have to report on your tax return if you sold and earned any interest or dividend from the stocks.

3. How Can I Sell My Stock Without Paying Taxes?

·       Save in retirement account or educational accounts

·       Giving your stock away as a gift

·       Staying on the lower tax bracket

·       Moving to state where the taxes are not so high

4. If I sell my stocks, will that count as an income?

Yes, if you sell your stocks at a profit, then that counts as an income (capital gain) and is subject to taxation.

5. Can I pay taxes if I reinvest my stocks?

Yes, the reinvested stocks can be taxed. The dividends earned from the stocks and mutual funds are taxable for the year when the dividends were paid, even if you consider reinvesting.