How Are Stock Profits Taxed?

How Are Stock Profits Taxed? article image.

Have you made money investing in the stock market? Before you spend your entire windfall, don't forget that the capital gains you make from profitable stock sales are taxable in addition to your regular income. You may even be required to pay quarterly tax estimates on your gains, meaning you could owe money to the U.S. government long before next year's tax deadline rolls around. Here's what you should know about paying taxes on stock profits.

What Are Capital Gains Taxes?

Capital gains are the profits you earn when you sell an investment for more than you paid for it. For example, if you buy 100 shares of stock X for $4,000 and sell them for $6,700, your capital gain is $2,700. Taxes on capital gains only apply to profits you make when you sell. If the value of your investments has risen but you haven't realized any gains by selling shares, you don't owe any taxes—yet. You'll pay taxes on these gains whenever you sell your stocks.

Both long-term and short-term capital gains are subject to tax. Long-term capital gains taxes apply to profits you make from investments you've owned for more than a year. If you've made a profit from stocks you owned for less than a year, as many people who've tried their hand at day trading have, your short-term capital gains are taxed as ordinary income.

How Long-Term Capital Gains Tax Works

For profits on investments held for more than a year, the tax rates are 0%, 15% and 20%, depending on your filing status and where your income falls on the chart below.

Long-Term Capital Gains Tax Rates for 2021
RateSingleMarried, Filing JointlyMarried, Filing SeparatelyHead of Household
0%Up to $40,400Up to $80,800Up to $40,400Up to $54,100
15%$40,401 - $445,850$80,801 - $501,600$40,401 - $250,800$54,101 - $473,750
20%$445,851 and up$501,601 and up$250,801 and up$473,751 and up

Source: IRS

Suppose you're single and your income for 2021 is $65,000. If you had owned stock X for more than a year, you would owe $405 (or 15%) in federal long-term capital gains tax on our hypothetical profit of $2,700. If your income was $500,000, you would owe $540 (or 20%) in taxes. And if your income was $39,000, you wouldn't owe capital gains tax at all.

How Taxes on Short-Term Capital Gains Work

But what if you turned a $2,700 profit on stock X in just two weeks? Your short-term $2,700 profit would be taxed at the same rate as your regular income.

Short-Term Capital Gains Tax Rates for 2021
RateSingleMarried, Filing JointlyMarried, Filing SeparatelyHead of Household
10%Up to $9,950Up to $19,900Up to $9,950Up to $14,200
12%$9,951 - $40,525$19,901 - $81,050$9,951 - $40,525$14,201 - $54,200
22%$40,526 - $86,375$81,051 - $172,750$40,526 - $86,375$54,201 - $86,350
24%$86,376 - $164,925$172,751 - $329,850$86,376 - $164,925$86,351 - $164,900
32%$164,926 - $209,425$329,851 - $418,850$164,926 - $209,425$164,901 - $209,400
35%$209,426 - $523,600$418,851 - $628,300$209,425 - $314,150$209,401 -

$523,600

37%$523,601 and up$628,301 and up$314,151 and up$523,601 and up

Source: IRS

Again, using our hypothetical example, if you're single and your income is $65,000, your short-term capital gains are taxed at 22%. If your short-term capital gain causes your income to rise into the next tax bracket, the portion of your gain that exceeds your current bracket will be taxed at the higher rate: For example, if you earn $39,000 and have a short-term capital gain of $2,700, the first $1,525 is taxed at 12% and the remaining $1,175 at 22%.

How to Lower Your Taxes on Stocks

Long-term capital gains generally have a tax advantage over short-term gains. One way to minimize your capital gains tax bill is to hold on to investments for at least a year before selling them. Your broker (or brokerage software) should track this information to help you avoid selling stocks before their time.

What if you're successfully making money on short-term gains? Even if your income puts you in a high tax bracket, short-term capital gains still put money in your pocket. As long as you're setting aside enough for taxes and paying your tax bills on time, short-term profits are a net positive.

Then again, most of us prefer a lower tax bill to a higher one. A few more ideas for keeping your tax bill down:

  • Invest money in retirement and college savings. Funds that are held in 401(k) and IRA retirement accounts aren't taxed until you withdraw money, generally in retirement. Any profitable trades you make within an account aren't taxed. Money in a Roth IRA is never taxed, even when withdrawn; the same is true for 529 education accounts, as long as withdrawals are spent on qualified expenses. So, if you're investing for the future and you'd like to keep your capital gains tax bill down, buying and selling stocks within your retirement plan or 529 plan is an option.
  • Offset gains with losses. When you sell stocks for less than you paid for them, the loss you incur can help offset your taxable gains.
  • Sell when your income is low. Another strategy: Sell profitable stocks when your income is lower, either because you've retired or you've had a "down" year. Remember: If your income is below $40,400 for a single person, or $80,800 for married people filing jointly, your long-term capital gains tax rate is zero.

Additional Tax Information to Consider

Quarterly tax estimates: If capital gains will likely increase your tax liability by $1,000 or more, consider making quarterly estimated tax payments on any capital gains you have throughout the year. Quarterly estimated tax payments for the 2021 tax year are due on the following dates:

  • April 15, 2021
  • June 15, 2021
  • September 15, 2021
  • January 18, 2022

IRS Form 1040-ES can help you calculate your payment—or consult with your tax advisor.

State taxes: You may also be subject to state taxes on capital gains. Check with your state tax board for more information.

If you're doing more than a few trades a year—or if you're even mildly confused about how these taxes apply to you—consulting with a tax professional may be wise. They can help you devise a tax strategy for your stock profits and keep you on track with any taxes you owe.

Relax and Enjoy the Profits

Calculating and paying taxes on your capital gains is definitely not the fun part of winning in the stock market. On the other hand, understanding and staying current on your tax liability can help you relax and enjoy the profits you've made. Keeping track of your capital gains, paying or setting aside taxes as you go and working with a trusted tax advisor can all help make the process more manageable.

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