Taxes on Stocks: What You Have to Pay and How to Pay Less
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Any profit you make from selling a stock is taxable at either 0%, 15% or 20% if you held the shares for more than a year.
If you held the shares for a year or less, you'll be taxed at your ordinary tax rate.
You may be able to reduce your taxes on stocks by holding investments in a tax-advantaged account, holding them for more than a year, and using losses to offset gains.
Investing in stocks can be a great way to build wealth and financial security, but it’s important to understand how taxes on stocks could affect your tax bill.
Do you pay capital gains tax on stocks?
If you sell stocks for a profit, you'll likely have to pay capital gains taxes. Generally, any profit you make on the sale of a stock is taxable at either 0%, 15% or 20% if you held the shares for more than a year, or at your ordinary tax rate if you held the shares for a year or less. Any dividends you receive from a stock are also usually taxable.
There are two types of capital gains taxes on realized stock gains:
Short-term capital gains tax
Short-term capital gains tax is a tax on profits from the sale of an asset held for a year or less. Short-term capital gains tax rates are the same as your income tax bracket. » MORE: Not sure what tax bracket you’re in? Learn about federal tax brackets.
Long-term capital gains tax
Long-term capital gains tax is a tax on profits from the sale of an asset held for longer than a year. Long-term capital gains tax rates are 0%, 15% or 20% depending on your taxable income and filing status.
Long-term capital gains tax rates are usually lower than those on short-term capital gains. That can mean paying lower taxes on stock sales.
» MORE: See the capital gains tax rates
Net investment income tax
Some high-income investors may also be subject to an additional 3.8% tax called the net investment income tax. The IRS imposes this tax on either your net investment income, or the amount by which your modified adjusted gross income exceeds a certain threshold (below), whichever one ends up being less.
The income thresholds for the net investment income tax are $250,000 for those married filing jointly, $125,000 for those married filing separately, and $200,000 for single filers and heads of household.
How are dividends taxed?
For tax purposes, there are two kinds of dividends: qualified and nonqualified. Nonqualified dividends are sometimes called ordinary dividends. The tax rate on nonqualified dividends is the same as your regular income tax bracket. The tax rate on qualified dividends is 0%, 15% or 20%, depending on your taxable income and filing status. This is usually lower than the rate for nonqualified dividends.
In both cases, people in higher tax brackets pay more taxes on dividends.
How and when you own a dividend-paying investment can dramatically change the tax bill on the dividends.
There are many exceptions and unusual scenarios with special rules; see IRS Publication 550 for the details.
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How to pay lower taxes on stocks
Think long term versus short term
You might pay less tax on your dividends by holding the shares long enough for the dividends to count as qualified. Just be sure that doing so aligns with your other investment objectives.
Whenever possible, consider holding an asset for longer than a year, so you can qualify for the long-term capital gains tax rate when you sell. That tax rate is significantly lower than the short-term capital gains rate for most assets. But again, be sure that holding the investment for that long aligns with your investment goals.
» MORE: Find out how a wealth tax works
Consider using investment capital losses to offset gains
The difference between your capital gains and your capital losses is called your “net capital gain.” If your losses exceed your gains, however, that's called a "net capital loss," and you can use it to offset your ordinary income by up to $3,000 ($1,500 for those married filing separately).
That's helpful in years when the stock market is down or volatile. Any additional losses can be carried forward to future years to offset capital gains or up to $3,000 of ordinary income per year.
Hold the shares inside an IRA, 401(k) or other tax-advantaged account
Dividends and capital gains on stock held inside a traditional IRA are tax-deferred, and tax-free if you have a Roth IRA; dividends and capital gains on stocks in a regular brokerage account typically aren’t.
Once money is in your 401(k), and as long as the money remains in the account, you pay no taxes on investment growth, interest, dividends or investment gains.
You can convert a traditional IRA into a Roth IRA so that withdrawals in retirement are tax-free. But note, only post-tax dollars get to go into Roth IRAs. So if you deducted traditional IRA contributions on your taxes and then decide to convert this to a Roth, you’ll need to pay taxes on the money you contributed, just like everyone else who invests in a Roth IRA. A backdoor Roth IRA allows individuals with high incomes to enjoy the benefit of a Roth IRA despite the IRS income limit.
If you invest with a robo-advisor, many offer free tax-loss harvesting, which involves selling losing investments to offset the taxes resulting from a capital gain.
Call in a pro
Your situation may be more complicated, so consider talking to a qualified tax preparer to help you make the right moves.
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