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The stock market climbing to record highs might have some people thinking, "Is it time to start investing in stocks?" That's up to you.
Investing in stocks can be a great way to build wealth and financial security, but it’s important to understand how taxes on the sale of stocks could affect your federal income tax bill.
Capital gains tax on stocks: Do you have to pay?
Yes. 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 an asset 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.
Do you pay taxes on stocks you don't sell?
No. Even if the value of your stocks goes up, you won't pay taxes until you sell the stock. Once you sell a stock that's gone up in value and you make a profit, you'll have to pay the capital gains tax. Note that you will, however, pay taxes on dividends whenever you receive them.
When the value of your stocks goes up but you haven't sold them, this is known as "unrealized gains."
Similarly, if the value of your stocks goes down and you haven't sold them, this is known as "unrealized losses." Selling a stock for profit locks in "realized gains," which will be taxed. However, you won't be taxed anything if you sell stock at a loss. In fact, it may even help your tax situation — this is a strategy known as tax-loss harvesting.
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How are stocks taxed?
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
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How are dividends taxed?
For tax purposes, there are two kinds of dividends: qualified and nonqualified. 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. The tax rate on nonqualified dividends, sometimes called ordinary dividends, is the same as your regular income tax bracket.
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.
» MORE: Learn more about how dividend taxes work
When do you have to pay taxes on stocks?
Taxes on stocks and dividends are incurred in the tax year when the stock is sold or the dividend payment is made.
By mid-February of the following year, you’ll get paperwork from your brokerage that will help you tally up your total gains and losses to determine the tax bill. For example, if you sold securities through a brokerage account in 2023, you’ll receive a1099-B, which will detail your transactions. You’ll use that information for your2023 tax return,filed in April 2024.
However, people who aren't subject to income tax withholding (such as freelancers) are often required to make quarterly estimated tax payments. If you're in that group, your dividend and capital gains tax would be due on the quarterly due date following the dividend receipt and/or sale.
If you aren't having enough tax withheld on your W-4 to cover the taxes incurred from the gain — or you expect the gain to have a big impact on your tax bill— paying estimated taxes can also help you avoid a surprise or underpayment penalty when you file.
What is net investment income tax?
Some high-income investors also may 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.
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How to pay lower taxes when selling stocks
1. 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.
2. Look into tax-loss harvesting
As a reminder, selling stock at a loss may come with tax advantages. 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).
This can be 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 of up to $3,000 ($1,500 for those married filing separately) of ordinary income per year.
3. Hold the shares inside an IRA, a 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 the 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. A Roth 401(k) has similar benefits as a Roth IRA: your investments grow tax-free and your money comes out tax-free in retirement.
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 your traditional IRA to a Roth, you’ll need to pay taxes on the money you contributed, just like everyone else who invests in a Roth IRA.
If you invest with a robo-advisor, many offer free tax-loss harvesting.
» Get started: Review our list of the best robo-advisors
4. Call in a pro
Your situation may be more complicated, so consider talking to a qualified tax preparer, tax-focused CPA or financial advisor to help you make the right moves.
