With taxes on stocks, many new investors may have a pleasant or unpleasant surprise waiting for them. It’s important to understand the different ways investments are taxed in the short-term and the long-term. In the US, there are many tools at our disposal to reduce the amount of taxes paid such as an IRA and a 401(k). Different investments also have different tax laws. Even a capital loss can sometimes work to our advantage. It is a very boring topic, but knowing its rules can save investors a good amount of money. This article will bring some tax laws to light and help everyone understand major tax rules regarding investments in the US.
What Are Taxes on Stocks?
We begin our taxes on stocks blog with taxes on short-term capital gains. This means any investment that was held for less than 12 months. This is especially important for day traders who make multiple trades per week and even more per year. Short-term capital gains are added to your yearly income.
What does this mean? If your income is usually $75,000 and you made $25,000 in short-term capital gains, your taxable income for the year becomes $100,000.
This means they can be taxed between 10% to 37%. The table below explains everything in detail for the next tax season. Remember that it is progressive, not cumulative. Every bracket is calculated separately.
Now, let’s calculate how much taxes on stocks a single person will pay on that $100,000.
10% of $10,275 = $1,027.50
12% of $10,276 to $41,775 = $3,779.88
22% of $41,776 to $89,075 = $10,405.78
24% of $89,076 to $100,000 = $2,621.76
Total taxes paid on $100,000 income is $17,834.92
The amount of taxes paid depends on the state. Many have their own rules and are much more advantageous than others.
In fact, residents of Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington and Wyoming do not pay income tax, so no capital gains taxes either. However, New Hampshire currently does tax interest and dividends. Other states offer certain incentives and tax breaks.
Long-Term Capital Gains Taxes
How are long-term capital gains taxed? It pays to hold your investments for more than 12 months. After the Tax Cuts and Job Act of 2018 passed, taxes on long-term capital gains changed for the best.
They were similarly taxed to short-term capital gains. Now, any gains below $41,675 aren’t taxed for a single person. The graph below better explains every situation.
In the case of our previous example, the $25,000 in capital gains would not be taxed if the person held on to the investment for 12 months. So what would be the taxes on stocks? Instead, they would only be taxed on $75,000. This would amount to a tax bill of $12,116.66. That is a difference of $5,718.26.
Stocks aren’t the only securities available to investors. How are other investment vehicles taxed?
Capital gains are taxed at a flat 28% rate regardless of the amount of capital gains or personal income.
Taxes on stocks can affect other things including collectables.
Another very common investment, especially in today’s crazy market, is real estate. What does taxes on stocks mean for this?
If the owner of the property owned and lived in their principal residence for two of the five years leading to the sale, up to $250,000 ($500,000 if married and filing jointly) of the capital gains of the sale can be excluded from taxable income.
If repairs and improvements were done on the property, they can be added to the base cost.
Let’s make this clearer with an example. You bought your primary residence 3 years ago for $400,000. Last year, you made renovations for $50,000.
The value of your home is now $450,000. Today, you sell your property for $750,000. If we deduct $250,000 from the profit, that leaves you $50,000 that is added to your income and taxed in the same way as a short-term capital gains tax.
If the property was sold for less than it was bought, it can’t be tax deductible.
Crypto & NFT
For those who are trying to escape the tax system with crypto, it might work for a while. However, it is still considered an investment and is taxed in the same way as the stocks above, depending on the duration of the investment (more or less than 12 months).
By the way, NFTs aren’t collectibles or art. They are also subject to the same rules as stocks. The IRS is still in the prehistorical times when it comes to tracking these transactions which can give many investors a break. However, it is playing with fire when you decide to ignore the applicable tax laws. Make sure you’re educated on taxes on stocks.
Taxes on Stocks: IRA & 401(k)
In the US, there are different ways to save money for retirement while paying fewer taxes. These affect taxes on stocks. An IRA and a 401(k) allow Americans to invest for their future under different tax conditions. Let’s take a look at both.
What is an IRA? It is an Individual Retirement Account. Anyone in the US can invest in this account for their retirement.
However, there is a difference between a traditional IRA and a Roth IRA.
In a traditional IRA, contributions can eventually be deducted from the tax return.
The earnings in that account can be tax-deferred until they are withdrawn upon retirement. Most people earn less money after retirement than during their career.
Hence, the money will be taxed in a lower tax bracket during retirement. The limit is $6,000 yearly for anyone under 50 and $7,000 for those over 50.
For a Roth IRA, the contributions aren’t tax-deductible. However, the withdrawals are tax-free and earnings grow tax-free as long as the account has been funded for at least 5 years.
Contributions are allowed as long as the yearly income doesn’t exceed $144,000. The question most face, is would they rather pay taxes now, or later?
It’s also possible to split the $6,000 between both accounts. In both cases, anyone has to be at least 59.5 years old to be able to withdraw from these accounts penalty-free. Therefore, know your taxes on stocks.
There is a second tool offered, a 401(k). This time, it is by employers. Employees can contribute a portion of their salary before tax up to a certain amount. Employers can also match all or a portion of the contribution.
For 2022, the maximum amount is $20,500 plus an extra $6,500 for anyone over 50 as a catch-up contribution. The money in this fund can be invested in different investment vehicles. Funds are subject to regular income tax upon withdrawal after the age of 59.5.
Both these tools can help Americans save for retirement, defer their taxes for later and invest their money smarter. There shouldn’t be any reason not to have both these accounts open.
Earlier, we spoke about capital gains, but what about capital losses?
In an ideal world, investors don’t want to have losing trades.
When they do happen, it’s possible to use them to our advantage.
They can offset capital gains, or when there aren’t any, they can be used towards our income tax.
The total sum can’t exceed $3,000 per year. If there are any capital losses left over, they can be used for upcoming years. When a company goes bankrupt, the entirety of the sum can be used, the $3,000 rule doesn’t apply. If the same stock is repurchased within 30 days, the capital loss becomes void in taxes on stocks.
Now You Know About Taxes on Stocks
In conclusion, figuring out taxes on stocks isn’t as difficult as it looks. For passive traders, it is easy to quickly calculate the amount owed in taxes. For day traders, it definitely takes a little longer to calculate.
It is also much clearer now how taxes are calculated on other investment vehicles such as real estate, collectibles, crypto and NFTs. In any case, many programs can do this on our behalf, or we can simply hire an accountant.
Having a basic idea of how much we can make and allocate to different programs to maximize our gains can save us a few thousand dollars every year. Anyone who can should definitely contribute to their IRA and 401(k) to have a more comfortable retirement. I hope this article shed some light on various tax questions.
If you want to learn more about how you can profit from the stock market, head on over to our free library of educational courses. We have something for everyone, including trading options for those with small accounts.