Not sure how to pay taxes on stocks?
Selling stocks can be a great way to boost your income, reap the benefits of your investments, and get funding for the big projects you want to start. However, when tax season arrives, there can be some unpleasant surprises if you don’t know what to expect.
If you don’t pay the right taxes on stocks, you might end up paying penalties to the IRS. And even if you follow all the rules, you might get hit with taxes that you weren’t expecting when it’s time to file. Don’t get left in the dark – get educated so you’ll know how to budget for taxes on stocks.
In this guide, we’ll help you understand how the capital gains tax might affect you. Keep reading for the information you need!
What is the Capital Gains Tax?
The term “capital gain” refers to how much money you make on a stock. If you sell the stock for more than you bought it for, you have capital gains that you’ll need to pay taxes on.
Of course, stocks don’t always go up in value before you sell them (although that’s the hope in investing). If you sell your stock for less than you bought it for, you’ll have a capital loss, and you won’t have to pay tax.
The capital gains tax applies because gains on stocks are a form of income, and you have to pay taxes on your income. However, business income doesn’t count as a type of capital gain. You’ll get taxed differently on any business income that you bring in over the year.
Who Pays the Capital Gains Tax?
It’s a common misconception that taxes on stocks only apply to the rich. However, anyone can end up with capital gains that they’ll need to pay taxes on at the end of the year.
Anytime you sell stocks, you might have to pay taxes on it. Other assets, as well as stocks, also count as property that you might have to pay taxes on. For example, if you invested in property, capital gains tax might apply to that when you sell it. Almost all kinds of capital gains are supposed to be reported when you do your taxes.
When Does the Capital Gains Tax Apply?
What are some common situations when the capital gains tax applies or changes? Let’s take a look at what to be aware of before tax season arrives.
The short-term capital gains tax applies to investments that you’ve had for a year or less. The tax rate for these short-term investments is calculated using your ordinary tax bracket.
If you have your investments for a year or more, you’ll be paying the long-term tax instead. These tax rates are also determined by your taxable income levels, but they are lower than the rates for short-term investments. Holding onto your investments longer can help you save money when it comes to paying taxes on stocks.
As mentioned above, the capital gains tax applies to many different investments, not just stocks. You’ll have to pay tax on gains realized from short- or long-term investments such as boats, cars, or real estate.
However, the capital gains tax won’t apply to the value of your home. For many people, this is their most valuable asset, and selling your home can result in huge gains. Luckily, you won’t have to pay this kind of tax on your home when you sell it. As long as you meet certain conditions, you’ll be exempt.
What if You Have Capital Losses?
Does the capital gains tax still apply when there are capital losses instead?
Capital losses don’t require you to pay taxes on them since you didn’t make a profit from the sale. And capital losses can also be valuable by helping offset the cost of the capital gains tax.
The amount of the losses can be subtracted from the amount of the gains, so you’ll only need to pay taxes on the difference between the two.
How to Pay Less Taxes on Stocks
Paying the capital gains tax can take a huge chunk out of your income from stocks. However, there are some ways you can reduce the amount of tax you’ll have to pay. Try these strategies so you can keep more of the money your investments have earned.
1. Open Tax-Advantaged Accounts
Some investment accounts are designed to help you save more on your taxes. Try an IRA, a 401(k), or another account with tax-deferred or tax-free gains. These types of accounts let you circumvent the capital gains tax.
In some types of accounts, such as Roth IRAs, you can even distribute qualified funds without paying any taxes at all. Since you put money into a Roth account after taxes, you can take out the contributions you made tax-free. You can also take out money from the gains for qualified reasons, such as education expenses.
2. Plan for the Long Term
Keeping investments for longer reduces the amount of taxes you’ll need to pay, so plan ahead and keep your investments until you can reap this tax benefit. The longer you wait, the more you stand to gain with many investments, so it’s a win-win situation.
3. Carry Over Capital Losses
If you have capital losses, you should always use them to help offset your capital gains. Sometimes, the amount of the loss will go over the amount you can deduct in a single year. If that’s the case, you can actually carry over the rest of the losses into the next year, and use them to offset your gains in the future, too.
Stay Prepared to Pay Taxes on Stocks
Paying taxes on stocks and other investments is a normal part of investing. As long as you inform yourself about what to expect, you won’t have any surprises when tax time comes, and you can take steps to minimize what you’ll owe.
However, if you weren’t ready for tax season and you find yourself in tax debt, don’t worry. There are ways to get out – read this post to learn more.