How Are Stocks Taxed?! (Capital Gains Explained)

Let’s talk about everyone’s favorite subject: taxes.

Yes, I know, a fun subject to talk about. But don’t worry, I will make it easy for you all to understand, and hopefully not too mind-numbing.

Keep in mind this post only applies to the US tax code.

Additionally, this blog post is for educational purposes only. I am not a CPA. I’m just a person who likes to learn about how money works.

Talk with a CPA for more information regarding your specific tax situation.

That being said, let’s dive in!

To start, you will only owe taxes on whatever Profits you made when you sell a stock AND whenever you are Paid Dividends.

There are 2 types of tax rates that apply to stocks.

The first one is Long-term Capital Gains and the second one is Short-term Capital Gains.

Let’s quickly define the two so you are aware of what they are.

What are Long-term Capital Gains?

Well, the name kind of gives it away.

Long-term capital gains are a way the government incentivizes long-term holding. The cool thing about Long-term capital gains is that your stocks are taxed at a much lower tax rate than Short-Term Capital Gains.

If you hold an asset for OVER a year before you sell, long-term capital gains will apply to your profits.

Long-term capital gains are taxed at either 0%, 15%, or 20%, depending on your tax bracket, as seen below.

What are Short-term Capital Gains?

Short-term capital gains apply if you hold a stock for exactly a year or LESS than a year.

Short-term capital gains are taxed as earned income. Which is at the same tax rate you would normally pay taxes on the money you made at a job. All the way up to 37%, as seen below.

So again, you will only owe taxes on whatever Profits you make when you sell a stock AND whenever you are Paid Dividends. Both selling for a profit AND being paid dividends are considered a taxable event by the IRS.

Let’s start with selling a stock for a profit

If you held a stock for MORE Than 1 year, and then go and sell that stock for a profit, YOUR PROFITS ONLY on that sale will be taxed as long-term capital gains, which are taxed at either 0%, 15%, or 20%, depending on whatever tax bracket you are in.

For example, let’s say you buy a stock for $100, and then decide to sell that stock 1.5 years later for $150. Only that $50 profit will be taxed as long-term capital gains. That’s it.

Now if you held a stock for exactly 1 year, or LESS and then go and sell a stock for a profit, YOUR PROFITS ONLY on that sale will be taxed as short term capital gains, which is taxed as earned income (up to 37%), depending on whatever tax bracket you are in.

What about dividends?

You will owe taxes on the total dividend payment. Even if your dividends are reinvested.

Being paid dividends is considered a taxable event and you will owe taxes on them.

(Unless you hold your stocks in a tax-exempt account, such as a Roth IRA, where taxes on dividends don’t apply as long as you meet the account requirements.)

Most dividends are taxed as “Qualified Dividends”, which are taxed as long-term capital gains, meaning either 0%, 15%, or 20% depending on your tax bracket.

Some dividends are taxed as “Ordinary Dividends” which are taxed as short-term capital gains (AKA earned income and up to 37%).

The best way to check if your dividends are qualified or ordinary is to go to dividend.com and look it up on their website to see how your dividends will be taxed. It will also be stated on your 1099 tax form at the end of the year if you decide to just wait until then.

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What about if you sell a stock for a loss?

If you have losses, they can offset any capital gains during the same taxable year.

If you don’t have any profits to offset for the same year, you can use any losses to offset your overall income of up to $3,000 per year.

So for example, if you sold a stock for a loss of $9,000 in 2022, and had no capital gains to offset that loss against, you could deduct $3,000 of those losses against your taxable income each year until all of your losses have been fully written off.

2022: $3,000 deduction

2023: $3,000 deduction

2024: $3,000 deduction

You’ll typically receive 1099 from your stock brokerage by February 15th of each year if you sold any stocks or received dividends. Contact your brokerage for more information regarding your 1099 tax form!

Keep in mind that the tax rates in this blog post are for federal taxes only. Many states tax for capital gains in addition to federal taxes as well.

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As Always: Buy things that pay you to own them.

-Josh

Blog Post: #009