When you’re holding stocks in a brokerage account, you don’t have to pay taxes on them, even if they’re increasing in value. It’s when you sell stocks that you may need to pay capital gains taxes if they were sold for more than the amount you bought them for. In addition, if you gained dividends from a stock that you hold, the cash dividends can potentially be taxed as regular income. Despite all of this, as long as you properly manage your investments, you do have some opportunities to decrease or eliminate the taxes you need to pay when selling your stocks. Here are some useful tips that will make paying taxes on stocks easier.
- Know how long you held the stocks.
A stock is a capital asset, so when you sell one for a profit, you have to pay the capital gains tax. The rates for short-term capital gains and long-term capital gains vary. The long-term rate is generally lower than the short-term rate. If you’ve held the stocks for more than a year before selling them, in most cases, you’ll qualify for the long-term rate. Long-term rates are usually 0%, 15%, or 20%, depending on what your regular taxable income is and your filing status. If the stocks were only held for a few months before you sold them, you’d have to pay the short-term rate. The short-term rate will be the same as the rate for your usual tax bracket. The tax brackets are adjusted every year for inflation. The IRS typically announces the bracket for the upcoming year before the end of the previous calendar year. You can find information on the IRS website.
- Find your adjusted basis.
The term “basis” refers to the amount that’s originally paid for the stock. You can find the adjusted basis by adding to your basis any commissions, fees, or other amounts that you paid to complete the original purchase transaction. If the stock was bought at different times, you might have different commissions and fees to take into account. Nonetheless, you’d report stock that you bought at different times as separate assets on your taxes. If you don’t remember the amount you paid for the stock or what fees and commissions were on the trade, you can look up the record of the transaction with your broker. If you happened to inherit a stock or one was given to you as a gift, your basis would be the fair market value in the stock at the time it was in your possession. If you’re uncertain of what that would be, a financial advisor or broker can assist you in figuring that out.
- Total the costs related to the sale.
When you’ve sold a stock, you usually pay fees and commissions. The IRS lets you subtract these costs from the amount that you made off the sale. This final amount is referred to as the “amount realized” on the transaction. If you paid the same amounts in commissions and fees buying the stock as you did when it was sold, the costs would likely cancel each other out. But then, it’s still important to get the right amounts to ensure you’re calculating your gains and losses correctly. Be sure to save your documentations for the commissions and fees you paid both when you purchased the stock and when you sold the stock. You might need to prove the calculations in the event of an audit.
- Subtract adjusted basis from the amount realized from the sale.
When the adjusted basis is smaller than the amount realized, that’s a capital gain. When the adjusted basis is larger than the amount realized, that’s a capital loss. When doing your calculation, a negative number will be your result if you have a capital loss. Capital losses still need to be reported on your taxes, though you won’t have to pay taxes on the amount. You can potentially use it to offset other capital gains. As an example, if you had $2,000 in long-term capital losses and $2,500 in long-term capital gains, the losses would offset $2,000 in long-term capital gains, and you’d only need to pay taxes on the $500 net gain.
- Report capital gains on Form 8949.
On Form 8949, you’ll write a description for your stock, the date it was acquired, the date it was sold, the amount realized for the sale, and the adjusted basis in the stock. Then, you’ll report your gain or loss from the transaction. Stock that has been bought at different times should be listed as separate assets, even if it was stock in the same company. If the tax return is going to be prepared by hand, the Form 8949 can be downloaded at the IRS website.
- Fill out Schedule D using Form 8849.
Transfer your data from the Form to the Schedule as instructed. If multiple transactions are reported, you’ll have to separately total short-term gains and long-term gains. They’ll be subject to different tax rates. Once Schedule D is completed, it will tell you the amounts to enter on Form 1040. If a total gain was realized, you’d pay taxes on that amount. If the total amount is a loss, you might be able to use it to offset other tax liability.
- Determine if dividends are nonqualified or qualified.
Depending on your income and filing status, qualified dividends are taxed at a 0%, 15%, or 20% rate. Nonqualified dividends, which are also referred to as “ordinary” dividends, are taxed at the same rate as your regular income. Dividends will usually become qualified after they’ve been held for at least a year. The tax treatment will be similar to the tax treatment for long-term and short-term capital gains. If you happen to be in a lower tax bracket, you might not have to pay any taxes on your dividends, but you’ll still be responsible for reporting them.
- Wait until you receive Form 1099-DIV.
Corporations generally issue dividends using Form 1099-DIV to report them at the end of the year. The Form will come in the mail typically around January or February. Given it’s an informational form, you won’t have to file it with your taxes, but it should be kept with your tax records for the year. Be mindful that not all corporations use a Form 1099-DIV, and you’re still responsible for reporting dividends that were received on your taxes even if you don’t get the Form.
- Report dividends received on Form 1040.
Dividend income will be asked for on line 3 of Form 1040. Ordinary dividends will be reported on line 3b, and qualified will be reported on line 3a. If you have over $1,500 in ordinary dividends, you might have to fill out Schedule B. If you’re using Form 1099-DIV, you’ll report your qualified dividends on box 1b and your ordinary dividends in box 1a.
- Hold shares long enough for dividends to be qualified.
Fewer taxes are paid on qualified dividends than on ordinary dividends. Your shares should be held at least for a year to reach qualified status. The tax rate for your dividends will be based on your filing status and taxable income. If you’re in a high tax bracket, you’ll pay 20% taxes on qualified dividends. Nonetheless, it may be lower than the rate you’d pay on your ordinary income. If you’re in a low tax bracket, it’s possible you won’t have to pay taxes at all on qualified dividends.
- Sell underperforming stocks.
If you sell some stocks and know you made some money, review your portfolio and identify some poorly performing stocks you can potentially get rid of. If they’re sold at a loss, the loss can be used to offset your gains. Be sure that the gains and losses are of the same character. The loss from short-term assets sold can’t be used to offset long-term gains and vice versa.
- Keep dividends and shares in a tax-advantaged retirement account.
Capital gains and dividends on stock held in a Roth IRA or 401k are tax-free. They also don’t have to be reported on your taxes. Along with not having to pay taxes on dividends or gains, you can also get a tax credit for contributions made to your retirement account during the year. Taxes on dividends and gains in a traditional IRA are deferred. That means you’ll have to pay the taxes once you start withdrawing from your account in retirement.
Another tip to keep in mind is if you happen to gain additional shares of a stock because of a stock split, you won’t need to pay any taxes unless some of the stock is sold. The IRS doesn’t consider a stock split to be a taxable event. Understanding how stocks and taxes work will help you make the best decisions to minimize the amount you have to pay. All of these tips can help you make paying taxes on your stocks as simple as possible. If you’re interested in finding help for getting your taxes done, you can find out more information at this link: https://taxfyle.com/.