Understanding and paying taxes is a dreadful task, mainly due to the complications and various implications in all disciplines. One such area is stock investments and trading. Paying taxes on stock trading is a lesser-known fact. While it is an effective way to strengthen your financial portfolio, the tax implications in stock trading can be a bit complicated. 

 

One wrong step could massively affect your tax bill and even your portfolio. To avoid this, it is necessary to understand the tax regime involved in trading stocks. Here’s a short and simple guide to help you pay taxes for trading stocks.

Understanding Taxes on Stocks

The first step towards successful tax payment is to understand it in and out. Ideally, if you own or hold a stock for over a year and make a profit from it, you are obliged to pay a tax rate of 0%, 15%, or 20%, depending on the time period and dividends received. Apart from this, the tax amount also depends on the income earned on an investment, ownership of the asset, and your annual income. Now, there are two ways of earning profit from selling stocks, which are from capital gains and income through dividends. 

Capital gains is when you sell your stocks for a higher price than your investment, and dividend income is the amount of money you earn through dividends on your stock holdings. Depending on the way you generate income through stocks, you pay taxes accordingly. For better understanding, let’s take a look at both ways in detail and respective tax implications.

Capital Gains Taxes

As mentioned, capital gains are achieved through selling your stocks at a higher price than what you paid initially. You must pay taxes on the profit you achieve. Any other investment asset that is sold to achieve a profit is also taxable. However, the amount you pay as taxes on capital gains varies and depends on several factors. These taxes are further divided into two categories:

Related News

  •       Long-term capital gains tax: If the asset or stock is retained for more than one year, you pay long-term capital gains tax from the profit you earn during that period. Depending on the time period of asset retainment, you need to pay a tax rate between 0%, 15%, and 20%. Other than this, the filing status is also considered. The tax amount on long-term capital gains is often lower than the one paid on short-term capital gains. Depending on the market status, the cap may vary from year to year.
  •       Short-term capital gains tax: If the asset or stock is retained for less than one year, you pay long-term capital gains tax from the profit you earn during that period. The tax amount usually aligns with the normal income tax bracket, making it a bit less complicated. In other words, if you pay 20% of regular income tax, you should pay 20% of short-term capital gain tax as well.

Dividend Taxes

Dividend taxes are paid on the income you make through dividends fetched on your stock holdings. Just like capital gains taxes, dividend taxes are also divided into two sub-categories, which are as follows:

  •       Qualified dividends: Depending on your profit margin, you need to pay a tax rate between 0%, 15%, and 20% and is often lower.
  •       Nonqualified dividends: Also known as ordinary dividends, you pay a similar tax amount as your regular income tax bracket.

Calculating the Tax Amount to be Paid

Consider aspects like the investment amount, paid commissions, and dividends that are reinvested to determine a solid investment figure. Calculate the profit by deducting the resale amount. You pay taxes on this amount. Consider different scenarios such as an inherited stock and calculate taxes accordingly. To make it easier, you can also rely on online tax calculators. If you are a 1099 contractor, determine the 1099 tax rate through an online calculator to cross-check. Similarly, if you are a business owner, calculate your tax rate accordingly.

To pay less taxes legally, consider long-term capital gains over the short-term. You can also consider your net capital gain, which is the difference in the amount between profit and loss on capital gains. If any circumstance, if the loss is higher than the profit, consider the tax return difference. Lastly, use tax supporting accounts such as IRA and 401(k) to avoid paying taxes on the amount deposited. Depending on the type of IRA or other tax-deferred account, you pay less or no tax at all.

As you can see, understanding taxes is key to paying them accurately and even lowering the taxable amount in the long run. It’s not as complicated as it looks. Just pay attention to the aspects mentioned above and you are good to go.