When the stocks you own have increased in value, it can be fun to get out the calculator and add up just how much you've made. But it's important to remember that if you sell, you might have to share some of your gains with the government. How much you'd pay in tax, if any, depends on your tax bracket and how long you have owned the shares.
Gains vs. Income
When you sell shares of common stock for a higher price than you paid for them, your profit isn't "income," as the Internal Revenue Service defines it. Rather, it's a "capital gain." This is a technical point but it's important, because in most cases capital gains are taxed at lower rates than regular income is taxed. However, you report your capital gains and pay capital gains taxes on your income tax return. Also, you don't have a capital gain unless you actually sell your shares; unrealized or "paper" gains don't exist, as far as the IRS is concerned.
Long-Term vs. Short-Term
The biggest single factor influencing the tax rate on your common stock gains is how long you owned the shares before you sold them. If you owned those shares for a year or less before selling them, you have a short-term capital gain. If you owned them for longer than a year, you had a long-term gain. Congress has the authority to change capital gains tax rates, and it hasn't been shy about doing so. (The rates changed about 10 times between 1990 and 2010.) But tax rates on long-term gains have traditionally been lower than rates on short-term gains.
The tax rate on short-term capital gains is the same as the top marginal rate on your regular income. In other words, whatever tax bracket you're in, that's the rate you pay on short-term gains. As of 2012, the United States had six brackets, and thus six tax rates for short-term gains: 10 percent, 15 percent, 25 percent, 28 percent, 33 percent and 35 percent. On long-term gains, as of 2012, taxpayers in the 10 percent and 15 percent brackets paid no tax at all. Taxpayers in the other brackets -- 25 percent through 35 percent -- paid 15 percent on long-term capital gains.
Reporting Capital Gains
To report capital gains, you'll need to include two IRS forms with your tax return. On the first, Form 8949, you list all your capital gains (and losses, if you have any), both short-term and long-term. You then use the second form, Schedule D, to determine how much to report in capital gains on your tax return, and to figure how much, if anything, you owe in capital gains tax.
Cam Merritt is a writer and editor specializing in business, personal finance and home design. He has contributed to USA Today, The Des Moines Register and Better Homes and Gardens"publications. Merritt has a journalism degree from Drake University and is pursuing an MBA from the University of Iowa.