Owning stocks offers you two ways to receive income -- by receiving dividends and by selling your stocks. Either way, you can be taxed. How much tax you pay, however, depends on several factors including how long you held the stocks. Depending on a number of factors, you may be taxed at capital gains tax rates or ordinary income tax rates. Capital gains tax rates are significantly lower than ordinary income tax rates.
The IRS divides dividends into two types -- qualified dividends and non-qualified dividends. Qualified dividends are taxed at capital gains tax rates, while non-qualified dividends are taxed at ordinary income tax rates. Qualified dividends are dividends issued by a U.S. or qualified foreign corporation, for stocks that you held for at least 61 days during a 121-day period beginning 60 days before the ex-dividend date, that are not otherwise disqualified under the Internal Revenue Code. The Internal Revenue Code disqualifies several types of dividends, including dividends issued by tax-exempt corporations and dividends paid on socks held in an employee stock ownership plans.
Sale of Stock
When you sell corporate stock for a profit, the IRS taxes you on your profit. The IRS measure of profit is equivalent to the sales price minus the stock's adjusted basis. Adjusted basis normally represents the amount you had to pay to acquire the stock -- the purchase price plus broker's fees, for example.
Short-Term vs. Long-Term Gains
Short-term capital gains from the sale of stock are taxed at ordinary income tax rates, while long-term gains are taxed at capital gains tax rates. Your gain is long-term if you held the stock for more than one year before selling it.
The IRS doesn't assess capital gains tax on a per transaction basis. Instead, you must aggregate your short- and long-term capital gains for all transactions during the tax year. If you made $12,000 in long-term gains on the stock market, for example, and incurred a capital loss of $15,000 from the sale of an apartment you rented out, you have a net capital loss of $3,000 assuming that these two transactions were your only capital transactions during the tax year. Note that you can deduct capital losses only if you held the property for investment purposes rather than personal use. The IRS offers a tax-free homestead exemption of $250,000 for profit on the sale of your main home.
Deductions and Carryovers
If your net capital losses exceed your net capital gains for the year, you can deduct up to $3,000 of your excess capital losses from your taxable income, and you can carry over any excess to future tax years. Capital losses for the sale of assets held for your personal use are not deductible, however. This means that the greater your capital gains from the sale of stock, the less you will be able to write off.
To report capital gains from the sale of stock, use IRS Form 8949 and Schedule D. You must also list your capital gains on Form 1040. Keep records of all transactions that contributed to your net capital gains in case the IRS decides to audit you.
- USA Today: How to Figure Your Capital Gains Taxes on Stock Sales
- Internal Revenue Service: Instructions for Form 8949 and Form 1040 Schedule D
- Forbes Magazine: Taxes from A to Z: Q Is For Qualified Dividends
- Internal Revenue Service: Ten Important Facts About Capital Gains and Losses
- Internal Revenue Service: Publication 550 (2011), Investment Income and Expenses
- Internal Revenue Service: Basis of Assets
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