With taxes on stocks, many new investors may have a pleasant or unpleasant surprise waiting for them. Understanding the different ways investments are taxed in the short and long term is important. In the US, many tools are available to reduce the taxes paid, such as an IRA and a 401(k). Different investments also have different tax laws. Even a capital loss can sometimes work to our advantage. It is a boring topic, but knowing its rules can save investors money. This article will bring some tax laws to light and help everyone understand major tax rules regarding investments in the US.
We begin our taxes on stocks blog with taxes on short-term capital gains. This means any investment that was held for less than 12 months. This is especially important for day traders who make multiple weekly trades and even more yearly. Short-term capital gains are added to your yearly income.
What does this mean? If your income is usually $75,000 and you made $25,000 in short-term capital gains, your taxable income for the year becomes $100,000.
This means they can be taxed between 10% to 37%. The table below explains everything in detail for the next tax season. Remember that it is progressive, not cumulative. Every bracket is calculated separately.
Now, let’s calculate how much taxes on stocks a single person will pay on that $100,000.
10% of $10,275 = $1,027.50
12% of $10,276 to $41,775 = $3,779.88
22% of $41,776 to $89,075 = $10,405.78
24% of $89,076 to $100,000 = $2,621.76
Total taxes paid on $100,000 income is $17,834.92
The amount of taxes paid depends on the state. Many have their own rules and are much more advantageous than others.
Residents of Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming do not pay income tax, so no capital gains taxes either. However, New Hampshire currently does tax interest and dividends. Other states offer certain incentives and tax breaks.
Long-Term Capital Gains Taxes
How are long-term capital gains taxed? It pays to hold your investments for more than 12 months. However, after the Tax Cuts and Job Act of 2018 passed, taxes on long-term capital gains changed for the better.
They were similarly taxed to short-term capital gains. Any gains below $41,675 aren’t taxed for a single person. The graph below better explains every situation.
In the case of our previous example, the $25,000 in capital gains would not be taxed if the person held on to the investment for 12 months. So what would be the taxes on stocks? Instead, they would only be taxed on $75,000. This would amount to a tax bill of $12,116.66. That is a difference of $5,718.26.
Stocks aren’t the only securities available to investors. So how are other investment vehicles taxed?
Collectibles
Not every investor sticks to stocks. Many collect art pieces (paintings, sculptures), antiques, jewelry, precious metals, collections, coins, and other collectibles.
Capital gains are taxed at a flat 28% rate regardless of the amount of capital gains or personal income.
Taxes on stocks can affect other things, including collectibles.
Real Estate
Another very common investment, especially in today’s crazy market, is real estate. What do taxes on stocks mean for this?
If the property owner owned and lived in their principal residence for two of the five years leading to the sale, up to $250,000 ($500,000 if married and filing jointly) of the capital gains of the sale can be excluded from taxable income.
If repairs and improvements were made on the property, they could be added to the base cost.
Let’s make this clearer with an example. You bought your primary residence three years ago for $400,000. Last year, you made renovations for $50,000.
The value of your home is now $450,000. Today, you are selling your property for $750,000. Deducting $250,000 from the profit leaves you $50,000 added to your income and taxed like a short-term capital gains tax.
If the property was sold for less than the purchase price, it can’t be tax deductible.
Crypto & NFT
For those trying to escape the tax system with crypto, it might work for a while. However, it is still considered an investment and is taxed in the same way as the stocks above, depending on the duration of the investment (more or less than 12 months).
By the way, NFTs aren’t collectibles or art. They are also subject to the same rules as stocks. The IRS is still in the prehistorical times when tracking these transactions can give many investors a break. However, ignoring the applicable tax laws is playing with fire. Make sure you’re educated on taxes on stocks.
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Taxes on Stocks: IRA & 401(k)
In the US, there are different ways to save money for retirement while paying fewer taxes. These affect taxes on stocks. An IRA and a 401(k) allow Americans to invest for their future under different tax conditions. Let’s take a look at both.
1. IRA
What is an IRA? It is an Individual Retirement Account. Anyone in the US can invest in this account for their retirement.
However, there is a difference between a traditional IRA and a Roth IRA.
In a traditional IRA, contributions can eventually be deducted from the tax return.
The earnings in that account can be tax-deferred until they are withdrawn upon retirement. Most people earn less money after retirement than during their careers.
Hence, the money will be taxed in a lower tax bracket during retirement. The limit is $6,000 yearly for anyone under 50 and $7,000 for those over 50.
For a Roth IRA, the contributions aren’t tax-deductible. However, the withdrawals are tax-free, and earnings grow tax-free if the account has been funded for at least five years.
Contributions are allowed as long as the yearly income doesn’t exceed $144,000. The question most face is whether they would rather pay taxes now or later.
It’s also possible to split the $6,000 between both accounts. In both cases, anyone has to be at least 59.5 years old to be able to withdraw from these accounts penalty-free. Therefore, know your taxes on stocks.
2. 401(k)
There is a second tool offered, a 401(k). This time, it is by employers. Employees can contribute a portion of their salary before tax up to a certain amount. Employers can also match all or a portion of the contribution.
For 2022, the maximum amount is $20,500 plus an extra $6,500 for anyone over 50 as a catch-up contribution. The money in this fund can be invested in different investment vehicles. However, funds are subject to regular income tax upon withdrawal after age 59.5.
Both these tools can help Americans save for retirement, defer their taxes for later and invest their money smarter. So there shouldn’t be any reason not to have both of these accounts open.
Capital Losses
Earlier, we spoke about capital gains, but what about capital losses?
In an ideal world, investors don’t want to have losing trades.
When they happen, we can use them to our advantage.
They can offset capital gains, or when there aren’t any, they can be used toward our income tax.
The total sum can’t exceed $3,000 per year. If there are any capital losses left over, they can be used for upcoming years. When a company goes bankrupt, the entirety of the sum can be used. The $3,000 rule doesn’t apply. If the same stock is repurchased within 30 days, the capital loss becomes void in stock taxes.
Final Thoughts: Taxes on Stocks
In conclusion, figuring out taxes on stocks isn’t as difficult as it looks. For passive traders, it is easy to quickly calculate the amount owed in taxes. However, for day traders, it takes a little longer to calculate.
It is also much clearer how taxes are calculated on other investment vehicles such as real estate, collectibles, crypto, and NFTs. But, again, many programs can do this on our behalf, or we can hire an accountant.
Having a basic idea of how much we can make and allocate to different programs to maximize our gains can save us a few thousand dollars yearly. Anyone can contribute to their IRA and 401(k) for a more comfortable retirement. I hope this article sheds some light on various tax questions.
