Whether at a job or through trading, paying taxes is a sort of dreaded word because each year is different and the amount of taxes paid will be different as well. Investing in stocks can be a profitable way to grow your income but traders should also understand that the government wants a piece of the pie if there are gains through trading.

Figuring out the taxes of your investments is not as easy as it seems but investors can do some things to minimize their capital tax gains each year. Each situation is different and more complicated so its best to talk to a certified account about your particular situation.

What Are Taxes on Stocks and Capital Gains?

Capital gains happen when a trader and investor sells an asset for a higher price than he/she bought it for. Just like the government takes a piece of every paycheck, the government also wants a piece of the profit realized from the sale of an asset. This is called the capital gains tax. For tax reasons, there is a difference between realized gains and unrealized gains. A gain is not realized until the profitable security is sold.

Generally, you do not have to pay taxes until there is realized profit. The tax paid on an asset also depends on how long the asset has been held before it has been sold. Even if you sold an asset for a profit, what you owe may not be a capital gains tax. There are two types of capital gains tax:

  • Short-term capital gains tax: A tax on profits from the sale of an asset held for a year or less than a year. This capital gains tax is the same as your usual income tax bracket. The tax rates are 10%, 12%, 22%, 24%, 32%, 35%, and 37%.
  • Long-term capital gains tax: A tax on profits from the sale of an asset held for longer than a year. Long-term tax rates include 0%,15%, or 20% which is dependent on your usual income tax bracket and filing status. Long-term capital tax rates are usually more favorable than the short-term capital gains.

Example of Capital Gains Tax

It helps to look at a fictitious example to get an idea of how a capital gains tax works. Let’s say you bought 100 shares of ABC stock for $40 and sold them all more than a year later for $70 per share. We can also assume you fall into the income category where the government will tax 15%.

If you bought a total of 100 shares for $4,000 and sold the shares for $70 for a total of $7,000, your capital gain is $3,000. You will be taxed a long-term capital gain of 15% for $450. The government keeps the $450 and you get to take home $2,550.

The government, in this case, takes a relatively smaller share of capital gains. If this were to be a short-term buy and sell trade, you could have been taxed up to 37% at ordinary income tax rates. Some traders may even have a lower tax rate through investing and trading than through their ordinary income.

How To Pay Taxes on Stocks

As investors and traders, we want to keep as much of the profits we earned as much as possible. Seeing most of the money go into taxes is not a nice thing after all the hard work that goes into investing and trading. By learning some of the steps you can take to reduce your tax rate for investment, taxes will not be as complex to think about.

There are some actions and steps you can take to minimize the amount of tax you have to pay the government each year. There are even ways for you to pay no taxes to the government if followed correctly. If you want to have an idea of what you can do to reduce or even avoid taxes, there are five things you can follow to grow your money even more:

Retirement Plans

Keep the shares inside an IRA, 401(k) or Roth IRA retirement plans. Although each has its own details, the benefits of using these plans as part of your trading and investment journey are that it can grow and you can buy and sell without the government taking its cut, so there are no capital tax gains.

Those investors who are near retirement benefit from waiting until they stop working to sell their assets and if retirement income is low enough, they might not even have to pay capital gains tax. Most plans don’t require taxes to be paid until the funds are withdrawn and this is taxed as ordinary income.

Long-term Investing

Taxes on capital gains for long-term investing are much more favorable than taxes for short-term traders. There are many companies that you can choose from that are good options to hold long-term.

If you choose to buy stock in companies you know well and are happy to put your money in, try to hold your stock for longer than a year so that you can qualify for long-term capital gains tax, which is lower than the short-term capital gains tax. Be sure that holding for this long is what you want to do for your investment plan and that it aligns with what you want to do with your money.

Use Capital Losses to Offset Gains

When you subtract the difference between capital losses and capital gains, you get a net capital gain. If you do have an investment loss, you can use it to decrease the tax of other investments. You can subtract the gain from the loss to have a lower gain to pay tax on. If you have more losses than gains, you can deduct the difference up to $3,000 per year on your tax return.

Keep Check on Holding Periods

If you are getting close to the year holding period but are not sure about the exact date and are thinking of selling the asset, make sure to figure out the date of purchase. If you are really close to being eligible for long-term capital gains tax, waiting a few more days can be advantageous. This, of course, is if the asset is not volatile during that time and the price is relatively stable. This can be a big difference for larger investments and investors in higher tax brackets.

Deductible Expenses

This trick is relatively unknown by most investors. The cost of management fees paid to brokers for mutual funds or advisory services can be deducted as an investment expense on Schedule A on your taxes. You can call your broker to find out how much was paid, and it is also good to use the advice of a certified accountant who can advise you on deducting these expenses.

Taxes have become a dreadful word for employees, employers, investors, and traders. By learning different methods of investing in assets and being more knowledgeable, taxes can be less intimidating. The above methods are things that can be done with the advice of your accountant. Taxes are a complex matter that should be taken seriously.

Minimizing taxes at the end of the year is what investors and traders are looking to do to keep more money in their pockets. There are ways to use both capital gains and losses to reduce taxes. If you hold your assets for more than a year and leave investments to grow inside a retirement plan, you can reduce the tax amount you pay the government. If you want to learn more about trading stocks, join one of RagingBull’s free webinars and get started on learning the basics today.

Jeff Williams

Jeff Williams is a full-time day trader with over 15 years experience. Thousands of entry-level and experienced traders alike – day-traders and swing-trade small cap stock traders – credit Jeff with guiding them to turning small accounts into big accounts.

Jeff’s "Small Account Challenge" shows people how to transform accounts from a few thousand dollars into $25k, $50k or even $100k.

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