You usually buy stock for one of two reasons. Either you are looking for a steady stream of dividend income, or you expect the market value of the stock to increase, providing you a capital gain. Any profit you make on your stocks is taxable as unearned income, and the Internal Revenue Service will want its share. Although it is illegal to evade paying taxes due on your stock market profits, some strategies can help you avoid, reduce or at least delay paying taxes on profits.
Hold onto your stock. Stock is a capital asset, just like your house, your car, your lawn mower and almost everything you own. There is no federal income tax on capital assets. You are taxed on gains only when you sell those assets. The stock in your investments portfolio can increase 100 times but it will not create a "taxable event," as long as you own the stock. You can choose when to pay taxes on the gains by choosing when to sell your stock. If you don't sell it, you don't owe taxes on profits.
Trade stocks in a tax-advantaged qualified retirement account, such as an individual retirement account. All of the investments in a qualified retirement account grow on a tax-deferred basis, regardless of how the growth occurs. Dividend income in your qualified account is not subject to current taxation. Neither are capital gains from buying and selling stock in your qualified account. With most types of qualified accounts you'll have to pay ordinary income taxes on withdrawals after you retire, when your income tax rate is likely to be lower than it was during your working years. This also allows you to choose when you want to pay taxes on your stock profits. If you hold your stocks in a Roth IRA, your qualified withdrawals are completely free from federal income taxes.
Use capital losses to offset your capital gains. Nobody wants to lose money in the stock market, but stocks go down as well as up. If you've sold stocks for a profit, and you are holding stocks that have dropped below what you paid for them, it might be worth your while to sell those stocks, take your capital loss, and use your losses to offset your capital gains. You can offset a dollar of gains for every dollar of losses. If you have more losses than gains, you can use some of those losses to reduce your other income.
- There are no guarantees in the stock market. Past performance is never a guarantee of future results.
- Fairmark: Capital Gains and Losses 101
- Fairmark: Basic Questions About Capital Gains and Losses
- Internal Revenue Service: Publication 590, Individual Retirement Arrangements
- Internal Revenue Service: Topic 409 - Capital Gains and Losses
- Internal Revenue Service: Ten Important Facts About Capital Gains and Losses