Taxes on Stocks: What You Have to Pay and How to Pay Less
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Investing can be a great way to build wealth and financial security, but it’s important to understand how the sale of stocks could affect your tax bill.
Do you have to pay taxes on stocks?
If you sell stocks for a profit, your earnings are known as capital gains and are subject to capital gains tax.
Generally, any profit you make on the sale of an asset is taxable at either 0%, 15% or 20% if you held the shares for more than a year, or at your ordinary tax rate if you held the shares for a year or less. Any dividends you receive from a stock are also usually taxable.
» MORE: Learn about federal tax brackets.
How are stocks taxed?
Profits from a stock are taxed as either short-term or long-term capital gains. Tax rates on long-term capital gains are usually lower than those on short-term capital gains. That can mean paying lower taxes — and sometimes even no tax — on profits.
Capital gains tax on stocks
Short-term capital gains tax: A tax on profits from the sale of an asset held for a year or less. Short-term capital gains tax rates are taxed as regular income, which means they're subject to federal income tax rates.
Long-term capital gains tax: Long-term capital gains tax is a tax on profits from the sale of an asset held for longer than a year. Long-term capital gains tax rates are 0%, 15% or 20%, depending on your taxable income and filing status.
» Dive deeper: How to calculate capital gains taxes
When do you pay taxes on stocks?
Taxes on stocks are incurred in the tax year the stock is sold or the dividend payment is made. Filers report and pay those taxes when they file their annual income tax return the following year. Form 1099-B — a summary of your trading activity — should arrive from your brokerage by mid-February, and this document will help you tally up total taxes on gains and losses.
However, some people may need to pay taxes sooner via estimated tax payments. This could occur because you aren't having enough tax withheld on your W-4 to cover the taxes incurred from the gain, or if your income isn't subject to income tax withholding (e.g., freelancers). Generally, if you expect to owe more than $1,000 in taxes when you file, paying estimated taxes can help you avoid getting hit with an underpayment penalty.
Your tax software or a qualified tax pro, such as a CPA, can help calculate how much and when to pay.
Do you pay taxes on stocks you don't sell?
No. Even if the value of your stocks goes up, you won't pay taxes until you sell the stock. Once you sell a stock that's gone up in value and you make a profit, that's when you'll have to pay the capital gains tax.
When the value of your stocks goes up, but you haven't sold them, this is known as "unrealized gains." Similarly, if the value of your stocks goes down and you haven't sold them, this is known as "unrealized losses." Selling a stock for profit locks in "realized gains," which will be taxed. However, you won't be taxed anything if you sell stock at a loss. In fact, it may even help your tax situation — this is a strategy known as tax-loss harvesting.
Note, however, that if you receive dividends, you will have to pay taxes on those.
How are dividends taxed?
For tax purposes, there are two kinds of dividends: qualified and nonqualified. The tax rate on qualified dividends is 0%, 15% or 20%, depending on your taxable income and filing status. This is usually lower than the rate for nonqualified dividends. The tax rate on nonqualified dividends, sometimes called ordinary dividends, is the same as your regular income tax bracket.
In both cases, people in higher tax brackets pay more taxes on dividends.
How and when you own a dividend-paying investment can dramatically change the tax bill on the dividends.
There are many exceptions and unusual scenarios with special rules; see IRS Publication 550 for the details.
» MORE: Learn how dividend taxes work
What is net investment income tax?
Some high-income investors may also be subject to an additional 3.8% tax called the net investment income tax. The IRS imposes this tax on either your net investment income or the amount by which your modified adjusted gross income exceeds a certain threshold (below), whichever one ends up being less.
The income thresholds for the net investment income tax are $250,000 for those married filing jointly, $125,000 for those married filing separately, and $200,000 for single filers and heads of household.
How to avoid taxes or pay less when selling stocks
1. Think long term versus short term
Holding the shares long enough for the dividends to count as qualified might reduce your tax bill. Just be sure that doing so aligns with your other investment objectives.
Whenever possible, consider holding an asset for longer than a year, so you can qualify for the long-term capital gains tax rate when you sell. That tax rate is significantly lower than the short-term capital gains rate for most assets. But again, be sure that holding the investment for that long aligns with your investment goals.
2. Look into tax-loss harvesting
As a reminder, selling stock at a loss may come with tax advantages. The difference between your capital gains and your capital losses is called your “net capital gain.” If your losses exceed your gains, however, that's called a "net capital loss," and you can use it to offset your ordinary income by up to $3,000 ($1,500 for those married filing separately).
This can be helpful in years when the stock market is down or volatile. Any additional losses can be carried forward to future years to offset capital gains of up to $3,000 ($1,500 for those married filing separately) of ordinary income per year.
3. Hold the shares inside an IRA, a 401(k) or other tax-advantaged account
Dividends and capital gains on stock held inside a traditional IRA are tax-deferred, and tax-free if you have a Roth IRA. Dividends and capital gains on stocks in a regular brokerage account typically aren’t.
Once the money is in your 401(k), and as long as the money remains in the account, you pay no taxes on investment growth, interest, dividends or earnings. A Roth 401(k) has similar benefits as a Roth IRA: your investments grow tax-free and your money comes out tax-free in retirement.
You can convert a traditional IRA into a Roth IRA so that withdrawals in retirement are tax-free. But note, only post-tax dollars get to go into Roth IRAs. So if you deducted traditional IRA contributions on your taxes and then decide to convert your traditional IRA to a Roth, you’ll need to pay taxes on the money you contributed, just like everyone else who invests in a Roth IRA.
If you invest with a robo-advisor, many offer free tax-loss harvesting.
» Get started: Review our list of the best robo-advisors
4. Call in a pro
Your situation may be more complicated, so consider talking to a qualified tax preparer, tax-focused local CPA or financial advisor to help you make the right moves.
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