Corporate stock can produce income in two ways -- dividends while you own your stock and profit when you sell it. Since it is income, you must report it to the Internal Revenue Service, and the IRS can tax it. Two possible tax rates apply, depending on the circumstances -- ordinary income rates and capital gains tax rates. You cannot be taxed on mere appreciation in the value of your stock until you sell it.
As of 2012, two tax rates apply to dividend income. If your dividend is "qualified," you pay tax at a maximum rate of 15 percent -- the same as the long-term capital gains tax rate. Your dividend is qualified if you meet the IRS holding period requirement : You must have owned the stock that yielded the dividend for at least 61 days during the 121-day period that begins 60 days before the ex-dividend date. The ex-dividend date is the day after the last day that new investors are entitled to receive the stock's next dividend. If you don't meet these requirements, your dividend is not qualified and you must pay ordinary income tax rates on it. The qualified dividend distinction is scheduled to disappear on Jan. 1, 2013, unless Congress and the President agree to extend it. If this occurs, taxes on dividends will be the same as on regular income.
Some dividend plans allow you to automatically reinvest your dividends in company stock. As long as you actually receive these dividends in cash, however, you must pay taxes on them. If your dividend plans allow you to purchase stock at preferential rates with reinvested dividends, you must also pay tax on the difference between your purchase price and the market price of the stocks.
You incur a capital gain when you sell your stock for a profit. For tax purposes, you must calculate your profit by subtracting your stocks' basis from the sale price. The basis normally equals the price you bought the stock for plus any other expenses incident to buying the stock, such as a stockbroker's commission. You only pay tax on the income if you realized a net capital gain on all transactions for the year, including non-stock-related transactions such as the sale of real estate. Long-term capital gains (for assets held more than a year before sale) are taxed at preferential capital gains rates, while short-term capital gains (all other capital gains) are taxed at ordinary income tax rates.
If you sell your stock for a loss, you must classify the loss as either short term or long term and determine your net short-term or long-term capital gain or loss for the year. Even if you realize a net capital gain for the year due to profit on other transactions, your capital loss from the sale of stock will be deducted from your net capital gain, thereby reducing your overall tax burden.
Any company that paid you more than $10 in dividends during the tax year must send Form 1099-DIV to both you and the IRS. Form 1099-DIV reports the amount of your dividends so you can calculate your tax. You report dividends on Form 1040 and Schedule B. You report capital gains and losses on Form 8949, Schedule D and Form 1040.
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