Get Access to 250+ Online Classes
Learn directly from the world’s top investors & entrepreneurs.Get Started Now
Taxes on your stock market investments can be complicated and reduce your overall profit. But there are ways to reduce your tax bill on your stock investments and pay less tax. You just have to know how.
In this article, we’ll look at:
- How stocks are taxed
- Ways to reduce your taxes on stocks
Let’s get started!
How Are Stocks Taxed?
There are several different ways stocks are taxed. Usually, investment income includes two items:
- interest income
The income you receive from dividends and interest is often taxed at your ordinary income tax rate. On the other hand, certain dividends may get special tax treatment and are generally taxed at lower long-term capital gains tax (CGT) rates.
How much tax you pay on your stock transactions depends on various factors, including:
- If you made a profit
- If you sell shares at a loss
- If you don’t sell share at all
We’ll look at each next.
If You’ve Made a Profit...
Typically, you only pay taxes when you receive a gain on the sale of investments, meaning that you sell your shares for a profit.
To figure out your taxes on stock gains, simply subtract the investment's cost basis — typically what you paid for the shares — from the sale price to determine if you made a profit and need to pay taxes on stocks.
If you’ve made a profit, they are taxed in two categories:
- Short term capital gains
- Long term capital gains
We’ll look at each one next.
One Year or Less — Short Term Capital Gains
Short-term capital gains take into effect when stocks are held for less than one year.
Short-term capital gains are taxed at the ordinary income tax rate, making it simple to calculate for your tax returns.
More Than One Year — Long Term Capital Gains
Long-term capital gains are incurred if you hold the shares for at least one year and sell them for a profit.
This means that capital gain is taxed at the long-term CGT rate, which is lower than most investors' ordinary income tax rates. Your taxes on stocks will be lower in this case.
If You Sell Shares at a Loss...
The good news is that taxes on capital gains or stocks only apply to profits you make when you sell. So, if you sell shares at a loss, you don't have to pay taxes.
You can also offset your capital gains with your capital losses to lower taxes on stocks — called tax loss harvesting — something we’ll look at later on.
If You Don't Sell Shares at All...
If you purchased securities or shares but did not sell anything in the current year, you won’t need to pay taxes on stocks.
This means that if the value of your investments has increased, but you have not realized any gains or profit by selling shares, you do not owe any taxes on stocks — yet. Instead, you will pay taxes on these gains when you sell your stocks.
How to Lower Your Taxes on Stocks
There are many ways you can reduce taxes on stocks — if you know how. Here are a few of those ways.
Donate Stocks to Charity
Donating stocks to a charity can help lower taxes on stocks and offers two potential tax benefits:
- You won’t be liable for any capital gains taxes due to the increase in value of your shares.
- You can use the market value of the shares on the day you donate them to the charity as a tax deduction if you're eligible to itemize deductions on your annual tax return. This will help lower taxes on stocks.
An effective option to lower taxes on stocks that is best for experienced stock investors, tax-loss minimizes the amount they pay in capital gains taxes by offsetting the amount they need to claim as income.
With this strategy, you intentionally sell stocks, mutual funds, or ETFs held in your taxable investment account at a loss.
You can use capital losses to offset your capital gains and reduce taxes on stocks as follows:
- Short-term losses offset your short-term gains
- Long-term losses offset your long-term gains
The Bottom Line: Taxes on Stocks
By understanding and staying current on your tax liability, you can stress less — and ensure that you maximize your stock earnings.