The S&P 500 is generally considered to be the standard measure of growth within the stock market. For the bulk of the past century, the return has been roughly 10% annually which is a testament to the profitability of the stock market. Keeping money in a savings account may seem like the best way to save your money, however, it inhibits monetary growth. Owning stocks is an easy way to stay ahead of inflation and take advantage of a growing economy. Many find themselves intimidated by the stock market and by the taxes, but once you know the basics you will find that it is easy and incredibly lucrative.
Tax on Purchase of Stocks
In the United States, it is not required to pay taxes on stocks that you purchase or hold. If your stock appreciates in value (capital gain), you will be required to pay taxes when you sell your stocks, but if your stock depreciates in value (capital loss), taxation will not be necessary and your losses can be used as a deduction.
Capital Gains Tax
If you net a capital gain (meaning the value of your stock went up since your original purchase), you will be required to pay taxes on the sale. There are two types of capital gains: Short-term and Long-term.
Short-term Capital Gains Tax
Short-term capital gains mean that the stock was held for a year or less. Short-term capital gains are taxed at your usual tax bracket (between 10% and 37%, based on income).
Long-term Capital Gains Tax
Long-term capital gains are stocks that were held for a year or more. These are taxed at either 0%, 15%, or 20%, also based on income.
Other Types of Stock Taxes
If you own a stock that pays dividends, you must pay taxes on those dividends. Most dividends are considered ordinary dividends, and they are taxed based on your tax bracket. Some dividends are considered qualified dividends. They are taxed based on the capital gains rate which varies between 0% and 20% based on income. If you reinvest your dividends, you are still obliged to pay taxes on the dividends. If you purchase stock at a discount, the discount is taxable as dividend income.
Inherited Stock Taxes
Similar to an inherited IRA, an Inherited stock follows the death of the original owner. You are not liable for the taxes when you receive the inherited stock, however, when you decide to sell the stock you will be liable for the selling taxes.
Donated Stock Taxes
Much like an inherited stock, the recipient of a donated stock will not be liable for the taxes when the stock is donated but will be liable for taxes when the recipient decides to sell.
Taxes and Retirement Plans
Some retirement plans, such as 401(k) plans, grow money using the stock market. For these types of plans, taxes are paid on the capital taken from the account.
Ways to save on stock taxes
Now if spending 37% of your income from stocks on taxes seems discouraging, there are some legal ways to reduce the amount you owe and to save thousands of dollars:
Offset Tax Gains By Selling Bad Stocks
Offset tax gains, or tax-loss harvesting, allows stockholders to roll capital losses to future gains and income during the same year. Doing so is a strategic way to maximize tax savings. In simplistic terms, this means that you can deduct your losses from the taxes indebted to reduce the total amount of taxes owed.
Watch Your Holding Periods
Depending on your income, it may be more profitable to hold your stocks for long-term capital gains. This requires holding the stock for a year or more.
Holding Your Shares in a Retirement Account
Many retirement accounts provide tax advantages. For example, people typically pay lower taxes on capital gains and dividends for stock held in a Roth IRA or a 401k.
Looking For More Ways to Save Money on Taxes?
We understand that this can be a lot of information to take in. If you are still confused we can help you file your taxes and save thousands. Don’t overpay when it’s not necessary! Schedule a FREE call and never pay unnecessary taxes again.