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Taxes on Stocks and How to Lower Them

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It doesn’t come as a surprise to most people that they have to pay taxes on the income that they earn working their job.

Some people are surprised, however, when they learn that taxes must be paid when they earn money investing in the stock market.

So how are stocks taxed?

Main Types of Taxes Paid on Stocks

There are two main types of taxes paid on stock earnings:

Capital Gains Taxes

Capital gains taxes are due when stocks are sold. The tax is assessed on your profit on the sale of the stock. If you sell a stock at a loss, you won’t owe tax upon the sale because there was no profit.

Capital gains tax rates are generally lower than ordinary tax rates.

Short-Term Capital Gains Tax

If you hold a stock for less than one year before selling it, your gain will be taxed at your regular income tax rate.

Short-term capital gains are taxed like other ordinary income, such as wages from a job. Your gains are simply added to your gross income and taxed according to your federal tax bracket.

There are exceptions to this rule, such as property acquired by gift, property acquired from someone who has died, or patent property. Check out the IRS rules.

Long-Term Capital Gains Tax

If you hold a stock for one year or longer, your gain will be taxed at the long-term capital gains tax rate.

Long-term capital gains are taxed separately at rates between 0% and 20%, though in a few instances they may be taxed at a higher rate.

Taxes on Dividends

Taxes on dividends, meanwhile, must be paid if a stock pays out dividends to investors. Ordinary dividends are taxed at ordinary income tax rates.

Qualified dividends that meet certain criteria are taxed at lower capital gains tax rates.

Note that dividends earned in a qualified retirement account such as a 401k or IRA are not taxable.

2022 Capital Gains Tax Rates

Following are the capital gains tax rates for the 2022 tax years. Note that income thresholds may rise each year due to inflation adjustments.

Short-Term Capital Gains Tax Rates

The tax rates for short-term capital gains are the same rates that apply to ordinary income. The income thresholds are adjusted each year for inflation.

Short-term capital gains rates for 2022

Tax Rate
Single
Married Filing Jointly
Head of Household
Married Filing Separately
10%
$0 to $10,275
$0 to $20,550
$0 to $14,650
$0 to $10,275
12%
$10,276 to $41,775
$20,551 to $83,550
$14,651 to $55,900
$10,276 to 41,775
22%
$41,776 to $89,075
$83,551 to $178,150
$55,901 to $89,050
$41,776 to $89,075
24%
$89,076 to $170,050
$178,151 to $340,100
$89,051 to $170,050
$89,076 to $170,050
32%
$170,051 to $215,950
$340,101 to $431,900
$170,051 to $215,950
$170,051 to $215,950
35%
$215,951 to $539,900
$431,901 to $647,850
$215,951 to $539,900
$215,951 to $323,925
37%
$539,901 or more
$647,851 or more
$539,901 or more
$323,926 or more

Long-Term Capital Gains Tax Rates

The tax rates for long-term capital gains are as follows for the 2022 tax year, though income thresholds will also rise due to inflation adjustments.

Long-term capital gains rates for 2022

Tax Rate
Single
Married Filing Jointly
Head of Household
Married Filing Separately
0%
$0 to $41,675
$0 to $83,350
$0 to $55,800
$0 to $41,675
15%
$41,676 to $459,750
$83,351 to $517,200
$55,801 to $488,500
$41,676 to $258,600
20%
$459,751 or more
$517,201 or more
$488,501 or more
$258,601 or more

How Are Capital Gains Taxes Calculated?

When you sell a stock, you don’t pay capital gains tax on the entire amount of the sale — you only pay it on your profit from the sale.

To calculate how much tax you owe, you must subtract how much you paid for the stock, along with any commissions and reinvested dividends, from how much you sold it for.

How to Potentially Avoid Taxes on Stocks

Many people have the same question: How do I avoid paying taxes when I sell stock?

There are a few ways to lower the capital gains tax bill you pay on profits from the sale of stock.

1. Deduct any management fees or commissions you paid to stockbrokers

You can claim fees paid for a bank, broker or a similar source as a tax deduction. You’ll report these fees on Schedule A of your tax return. Additionally, the bill for investment counseling, certain accounting, or legal services in relation to your investment income can be considered as well.

2. Use tax-loss harvesting

This strategy involves selling underperforming investments and booking a loss.

You can use these losses to offset up to $3,000 each year in taxable investment gains and ordinary income if you don’t have this much in gains.

Unused investment losses each year can be carried forward to offset capital gains and ordinary income in future years.

For example, let’s say you realized a taxable profit on a stock sale this year of $5,000.

However, you own a stock that has fallen in value by $2,000 and you don’t expect it to recover anytime soon. You could sell this stock, book the $2,000 loss, and reduce the taxable gain on the other stock to just $3,000.

Note that you can buy back the stock you sold at a loss if you wait at least 30 days to do so. If you buy it back sooner than within 30 days, the IRS will disallow using the loss to offset the capital gain. This is known as the wash-sale rule.

3. Invest in tax-advantaged retirement plans

There are several types of retirement plans that can be beneficial for lowering your taxes.

Consider your current and expected future tax brackets to be the primary driving factors in determining which tax-advantaged account is most suitable for you.

Tax-Deferred Plans

With a tax-deferred retirement plan, tax savings are realized when you make contributions. Retirement withdrawals from the account will be taxed at your ordinary income rate.

Traditional IRA

Traditional IRAs are retirement accounts that you open (not through an employer) and fund yourself with eligible earned income.

Rollover IRA

Rollover IRAs are accounts that permit you to transfer funds from previous employer-sponsored retirement plans into an IRA.

SEP IRA

SEP IRAs are profit-sharing plans that allow business owners to contribute to both their employees’ retirement savings and their own.

Traditional 401k

One of the most popular and widely known investment tools, the 401k, is an employer-sponsored retirement plan that lets you save for retirement in a tax-sheltered manner.

Tax-Exempt Plans

Tax-exempt accounts don’t deliver a tax benefit when you contribute to them. However, withdrawals are tax-free in retirement.

ROTH IRA

Roth IRA contributions cannot be deducted from your income taxes. However, you will not need to pay taxes on withdrawals under the right circumstances.

ROTH 401k

In addition to a traditional 401k plan, some employers may also offer a Roth 401k option for employees. Roth 401k contributions are made with after-tax dollars. These accounts provide fully tax-free withdrawals someday as long as you follow the rules.

Next Steps for You

Taxation of gains on stock sales can be complicated. With this in mind, be sure to talk to your tax advisor and personal financial planner for guidance in your specific situation.

To stay on top of tax optimization, you can manage your money with free, online financial tools. Millions of people use Personal Capital’s free tools to see all of their financial accounts in one place.

When you sign up for the tools below, you also get access to the free guide 5 Tax Hacks Every Investor Should Know.

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The information and content provided herein is general in nature and is for informational purposes only. Individuals should contact their own professional tax advisors or other professionals to help answer questions about specific situations or needs prior to taking action based on this information. Tax laws and authorities are subject to change, either prospectively or retroactively, and any subsequent change could have a material impact on your situation. The content contained in this blog post is intended for general informational purposes only and is not meant to constitute legal, tax, accounting or investment advice. You should consult a qualified legal or tax professional regarding your specific situation. Keep in mind that investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money. Any reference to the advisory services refers to Personal Capital Advisors Corporation, a subsidiary of Personal Capital. Personal Capital Advisors Corporation is an investment adviser registered with the Securities and Exchange Commission (SEC). Registration does not imply a certain level of skill or training nor does it imply endorsement by the SEC.

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