You may have to pay capital gains tax when you realize a profit from the sale of investment assets, including corporate stock. Although capital gains tax rates are typically lower than ordinary income tax rates, these rates do not apply to short-term capital gains. Short-term and long-term capital gains are also treated differently when it comes to offsetting capital losses.
How Capital Gains Tax Works
Capital gains tax is levied on amounts you actually make from the sale of stock. Gains that appear only on paper don't count, because paper gains don't generate any money with which to pay the tax. To calculate your capital gains tax liability, you must take into account all of your capital gains and losses during the tax year, whether or not related to the sale of stock. Generally, you are liable for capital gains tax on profits made from the sale of any capital asset held for investment purposes.
Determining the Amount
The IRS determines the amount of your capital gain based on your actual profit from the sale of stock -- the amount you actually received from the sale minus the stock's "adjusted basis." Normally, adjusted basis refers to the amount you originally bought the stock for minus any costs of sale, such as broker's fees. If there was a stock split while you owned the stocks, however, you must reduce the stock's adjusted basis based on your stocks' real value after the split.
Long-term vs. Short-term Tax Rates
You realize a short-term capital gain when you sell a stock for a profit after holding it for a year or less. If you hold the stock for more than a year before selling it, you realize a long-term capital gain on any profit. Short-term capital gains are taxed at ordinary income tax rates, while long-term capital gains are taxed at capital gains tax rates. As of 2012, the top individual income tax rate was 35 percent, while the top capital gains tax rate was 15 percent.
Deducting Capital Losses
Your capital gains aren't treated in isolation. You may deduct your capital losses from your capital gains to reduce your taxable capital gains. To do this, you must aggregate all of your capital gains during the tax year and separate them into short-term and long-term capital gains. You must also aggregate and separate your capital losses during the tax year. Finally, you subtract short-term capital losses from short-term capital gains, and subtract long-term capital losses from long-term capital gains. Under certain circumstances, you can carry over excess capital losses to future tax years.
- IRS: Topic 409 -- Capital Gains and Losses
- IRS: Ten Important Facts About Capital Gains and Losses
- Bankrate.com: Reporting Your Capital Gains (or Losses)
- IRS: 2011 Instructions for Schedule D (and Form 8949)
- IRS: IRS Reminds Taxpayers They Can Use Stock Losses to Reduce Taxes
- IRS: Sales and Trades of Investment Property
David Carnes has been a full-time writer since 1998 and has published two full-length novels. He spends much of his time in various Asian countries and is fluent in Mandarin Chinese. He earned a Juris Doctorate from the University of Kentucky College of Law.