You know that any income you earn, whether it’s from a job, rental property, or business venture, is taxed by the IRS, but what about stocks and bonds? While any profit you make from stocks is taxed, it’s somewhat different than earned income. To help you understand capital gains and dividends, our CPAs in Raleigh are sharing a closer look at how you pay taxes on stocks.
Understanding the Capital Gains Tax
If your stocks are all held in a traditional brokerage account (as opposed to an IRA or 401K), they won’t be taxed just sitting there. However, if you sell stock and make a profit, that profit is subject to the capital gains tax. This is the amount you pay when you sell any asset for more than you had paid, whether it’s a rental home, car, collectible, or stock.
Capital gains is figured like this: selling price – purchase price – selling costs = profit subject to capital gains tax. For example, let’s say you buy 10 shares of stock in ACME Company at $30, and 10 years later, it’s worth $80 a share, so you sell 5 shares. You would be taxed on the profit you made from selling 5 shares of the stock. ($80×5) – ($30×5) = $250 profit.
Short Term Capital Gains
If you sell an asset you’ve held for less than one year, the gain is considered a “short-term capital gain” which is taxed at your ordinary income rate, which is often much higher than the long-term rate.
Let’s look at our ACME stock again.
Assume you are in the 22 percent tax bracket. In February, you bought five shares of ACME stock for $30 each and, 10 months later you sell them for $80 each. The $250 gain will be taxed at your 22 percent tax rate, making your after-tax profit $195.
Long Term Capital Gains
If you hold on to an asset longer than one year before selling, it’s considered long-term capital gains, and will be subject to the capital gains rate of 0, 15, or 20 percent, depending on your overall income. In our example above, if you hold on to those stocks for another two months and were in the highest tax bracket with a 20 percent capital gains tax, your ACME stock after-tax profit would increase to $200. Stocks that you inherit are automatically considered to be held for more than one year.
Taxes on Stock Dividends
For investments you own, you may receive periodic payments, called dividends, for them. A dividend occurs when a company generates a profit, and the earnings are distributed to shareholders. Going back to the ACME example, if each share of their stock generates $2 in after-tax profit, the board may deliver a percentage of that profit back to the shareholders in cash. If you have 100 shares, and the dividend yield is $1.50 per share you own, you’d get $150.
How a dividend is taxed depends on whether it is qualified or unqualified. Qualified dividends fall under the capital gains tax rate and must meet the following requirements:
- Dividend must be paid by a US company or qualifying foreign company;
- Not listed as an unqualified company by the IRS;
- Has met the dividend holding period.
Most regular dividends are qualified.
Unqualified dividends are taxed at the higher income tax rate. Examples of unqualified dividends include those paid by real estate investment trusts, employee stock options, and tax-exempt companies. Money market dividends do not qualify and are considered interest income.
Schedule a Consultation with Our CPAs to Discuss Your Taxes
When it comes to paying taxes on stocks, investments, and other financial holdings, it doesn’t take long for these matters to become complicated and confusing, and mistakes can be costly. At Steward Ingram & Cooper, PLLC, we have the experience and knowledge to guide you through these complexities and minimize your tax burden. Schedule a consultation today at (919) 872-0866 or by filling out the form below. We serve Raleigh, Durham, Wilson, Wake Forest, and surrounding areas.