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Owning Stocks Affects Your Taxes
Yes
Owning stocks means a little more work at tax time—either for you or for your tax professional. Either way, you’ll want an idea of how your tax liability is affected, if for no other reason than to have the correct paperwork ready when it comes time to give all of your tax-applicable documents to your CPA.
Buying or selling stocks
If you sell stocks (and/or other types of investments) and make money from the sale, it’s called a capital gain, and you’ll need to pay tax on those profits. Capital gains are taxed at different rates, depending on if the stock sold is considered a short-term or long-term holding.
A short-term investment is held for less than a year and is taxed at your income tax bracket rate—up to 37% depending on your income. A long-term investment is held for longer than a year and is taxed at 0%, 5%, or 20% depending, again, on your tax bracket.
Now, you won’t need to pay tax on the full check amount you receive from the sale. You can subtract your basis. A basis is the cost of the stock plus any reinvested dividends and commissions paid for its original purchase—say to a broker. If you inherited the stock, then the basis is the fair-market value of the stock when the descendent dies (or alternate valuation date). If you received it as a gift, the basis is the lower of the fair-market value or the basis of the donor at the time the gift was made.
The basic formula for calculating a sold stock’s profit or loss is:
Sales Proceeds – Basis = Taxable Profit or Deductible Loss
If you lose money on the sale of a stock, it’s called a capital loss. You can deduct the amount you lost from any capital gains you received from the sale of other investments to lower your overall taxable income. However, there is a limit to how much you’re allowed to deduct on your tax return for capital losses: $3,000 per year. The good news is that any remaining loss amount can be applied to future years to lower tax liability.
Regardless of if you net a loss or gain from the sale of stocks, both scenarios could affect your tax bracket.
Dividends
Selling your stock isn’t the only way they can affect your taxes. If you receive periodic payments, called dividends, from your stock investments, you’ll need to pay tax on that income. Ordinary dividends are taxed at regular income tax rates and not at capital gains rates. Qualified dividends are taxed at a capital gains rate of 0% to a maximum of 15%. Dividends are qualified if they are paid by a U.S. corporation or a qualified foreign corporation and the holding period of the stock is greater than 60 days
Filing taxes
You should receive a 1099-DIV form from each company or fund that sent you dividends throughout the year. You should also receive a 1099-B form from your investment brokerage showing your capital gains for the year. It’s important to put all of these forms together for your accountant or for your own use so you can properly report your income and not pay any more tax than necessary.