No one likes to pay taxes, but unfortunately, we all have to, and it's not only limited to income, but also to investments. Today we'll be looking at how stocks are taxed which is by no means at a fixed rate. Everyone pays different taxes depending on several criteria including income, type of trade, length of trade, account, etc... You'll learn about all of them and be more knowledgeable about your investment decisions and understand your accountant better when tax season rolls around.
Short-Term Capital Gains
Stocks, ETFs, and equity options sold at or below 365 days (1 year) are subject to short-term capital gains tax. This also includes selling covered calls and cash-secured puts no matter when the expiration is because the money has been credited to the account and is considered short-term capital gains.
Short-Term Capital Gains Tax Rates for 2022
Rate | Single Filers | Married Couples Filing Jointly | Head of Households |
10% | Up to $10,275 | Up to $20,550 | Up to $14,650 |
12% | $10,275 - $41,775 | $20,550 - $83,550 | $14,650 - $55,900 |
22% | $41,775 - $89,075 | $83,550 - $178,150 | $55,900 - $89,050 |
24% | $89,075 - $170,050 | $178,150 - $340,100 | $89,050 - $170,050 |
32% | $170,050 - $215,950 | $340,100 - $431,900 | $170,050 - $215,950 |
35% | $215,950 - $539,900 | $431,900 - $647,850 | $215,950 - $539,900 |
37% | $539,900+ | $647,850+ | $539,900+ |
All income levels are taxed for short-term capital gains which is a big disadvantage and shows that the government promotes long-term investing by offering tax advantages. Take into consideration how long you're going to hold the investment and maybe hold it for over a year even if you're going to sell it less to avoid paying high taxes.
Long-Term Capital Gains
Stocks, ETFs, and equity options sold at or above 366 days (1 year) are subject to long-term capital gains tax.
Long-Term Capital Gains Tax Rates for 2022
Rate | Single Filers | Married Filing Jointly | Head of Households |
0% | $0 - $41,675 | $0 - $83,350 | $0 - $55,800 |
15% | $41,676 - $459,750 | $83,351 - $517,200 | $55,801 - $488,500 |
20% | $459,750+ | $517,200+ | $488,500+ |
Long-term capital gains come with a major tax benefit and a big opportunity to pay $0 in taxes and at most 20% which you would have to be part of the top 1% of individuals. This helps promote long-term investing with much cheaper taxes resulting in bigger gains.
Dividends
There are 2 different types of dividends: Qualified and Unqualified.
The main difference between the two is if they meet the requirements set by the IRS and of course the tax brackets. Unqualified will be taxed at a much higher rate than qualified dividends.
How to qualify for Qualified Dividends
Own shares of a U.S. company or qualifying foreign company
Required minimum holding period must be met (61 days for common stock, 91 days for preferred stock)
Foreign companies must meet one of the three requirements
They must be incorporated in the U.S
Be eligible for the benefits of a comprehensive income tax treaty with the U.S.
Be readily tradable on an established U.S. securities market
The one requirement you need for qualified dividends is just to hold the stock... that's it. You don't need to perform anything and all the stocks on the U.S. exchange are available for qualified dividends.
Unqualified Dividends Tax Rates for 2022 (same as short-term capital gains)
Rate | Single Filers | Married, Filing Jointly | Head of Households |
10% | Up to $10,275 | Up to $20,550 | Up to $14,650 |
12% | $10,276 - $41,775 | $20,551 - $83,550 | $14,651 - $55,900 |
22% | $41,776 - $89,075 | $83,551 - $178,150 | $55,901 - $89,050 |
24% | $89,076 - $170,050 | $178,151 - $340,100 | $89,051 - $170,050 |
32% | $170,051 - $215,950 | $340,101 - $431,900 | $170,051 - $215,950 |
35% | $215,951 - $539,900 | $431,901 - $647,850 | $215,951 - $539,900 |
37% | $539,900+ | $647,850+ | $539,900+ |
Qualified Dividends Tax Rates for 2022 (same as long term capital gains)
Rate | Single | Married, Filing Jointly | Head of Household |
0% | $0 - $41,675 | $0 - $83,350 | $0 - $55,800 |
15% | $41,676 - $459,750 | $83,351 - $517,200 | $55,801 - $488,500 |
20% | $459,750+ | $517,200+ | $488,500+ |
Dividends are great, but qualified dividends are much better! Plan on holding your stock for the long term and you'll receive passive income with a very low tax rate!
Loss Tax Deduction
If you don't have capital gains to offset the capital loss, you can use the capital loss as an offset to ordinary income, up to $3,000 per year. If you lose more money then you can offset it to years ahead to deduct from your taxes.
Example
Short-Term Gain = $0
Short-Term Loss = $20,000
Long-Term Gain = $8,000
Long-Term Loss = $1,500
Short Term = $0 - $20,000 = -($20,000)
Long Term = $8000 - $1500 = $6,500
Netted against each other you have a net loss of $13,500.
You can't deduct all of this at once so first year you deduct $3,000 then you have $10,500 leftover. If you earn less than $10,500 next year then you can use the $10,500 available to deduct and not have to pay any taxes the following year. So if you made a $20,000 gain next year you will be taxed for $9,500.
Using a capital loss to reduce your tax bill can be useful if you no longer want to hold the stock. If you're expecting the prices to be lower in the future then it can be useful because you'll pay less taxes and have more shares or vice versa can happen where you have fewer shares. You can't sell and purchase a stock right away to qualify. You must wait more than 30 days to repurchase the same asset if you want to deduct your capital loss.
Roth IRA Tax Advantages
Investing for retirement? Roth IRA is the best solution. Your investments will be completely tax-free if withdrawn at the retirement age of 59 1/2 or after. Make sure you plan on not withdrawing your money until retirement or else you will be paid a hefty tax bill and penalty. You will be taxed at your income tax bracket and pay an additional 10% penalty fee. There are exceptions to the 10 percent penalty, such as using IRA funds to pay your medical insurance premium after a job loss. Plan on using this tax-free system for retirement and have other investment accounts to invest in whatever you would like and withdraw your money anytime.
Recap
Whatever you earn in your life, you will be taxed. So why not learn about it and take advantage of the tax system to pay as low as possible? The easiest way to lower your taxes is to get married... please don't get married just to pay less taxes. But marriage does help reduce costs in taxes for both income and investments, so it might be worth taking into consideration. These are all you need to know about the stock market tax system, your CPA will know all of these but now you can invest accordingly and set new strategies to lower your taxes and increase your gains. Your brokerage will also have the tax documents readily available when it's tax season which will make your job just that much easier!