Paying tax is very important when playing in a financial market such as the stock market. If you sell stock for more than you originally paid for it, you may have to pay taxes on your profits.
Having understood the concept of the stock market, it is also important to know how to tax capital gain.
In this article, we’ll learn how to tax capital gain in stocks. Before then, let’s understand more about capital gains in stocks.
What is a Capital Gain?
A capital gain is any profit from the sale of a stock, and it has unique tax implications. Here’s what you need to know about selling stock and the taxes you may have to pay.
How to calculate profits from selling stock
When you sell stock, you’re responsible for paying taxes only on the profits — not on the entire sale.
To determine profits, take your total proceeds and subtract your cost basis (also known as your tax basis), which consists of the amount you paid to buy the stock in the first place, plus any commissions or fees you paid to buy and sell the shares.
Cost basis = Price paid for stock + Commission and fees
Profits = Proceeds from sale-cost basis
Example of how to calculate profits from a stock sale
Let’s say you bought 10 shares of stock in Company X for $10 each and paid $5 in transaction fees for the purchase. If you later sold all the stock for $150 total, paying another $5 in transaction fees for the sale, here’s how you’d calculate your profits:
Cost basis = $100 (10 shares @ $10 each) + $10 (purchase and sale fees @ $5 each) = $110 profits = $150 – $110 = $40
So in this example, you’d pay taxes on the $40 in profits, not the entire $150 total sale price.
Now that you’ve determined your profits, you can calculate the tax you’ll have to pay. The taxes you owe depend on your total income for the year and the length of time you held the shares.
Short-term and long-term capital gains taxes
If you held your shares for one year or less, then profits from the sale will be taxed as short-term capital gains. If you held your shares for more than one year before selling them, the profits will be taxed at the lower long-term capital gains rate.
Both short-term and long-term capital gains tax rates are determined by your overall taxable income. Your short-term capital gains are taxed at the same rate as your marginal tax rate (tax bracket). You can get an idea from the IRS of what your tax bracket might be for 2022 or 2023.
For the 2022 tax year (i.e., the taxes most individuals will file by April 17, 2023), long-term capital gains rates are either 0%, 15%, or 20%. Unlike past years, the break points for these levels don’t correspond exactly to the breaks between tax brackets.
How to avoid paying taxes when you sell stock
One way to avoid paying taxes on stock sales is to sell your shares at a loss. Although losing money certainly isn’t ideal, losses you incur from selling stocks can be used to offset any profits you made from selling other stocks during the year.
If your total capital losses exceed your total capital gains for the year, you can deduct as much as $3,000 of losses against your total income for the year. You can carry any additional losses into the following tax year.
However, you can’t sell a bunch of shares at a loss to lower your tax bill and then turn around and buy them right back again. The IRS doesn’t allow this kind of “wash sale” — called by this term because the net effect on your assets is “a wash” — to reduce your tax liability. If you repurchase the same or “substantially similar” stocks within 30 days of the initial sale, it counts as a “wash sale” and can’t be deducted.
Of course, if you end the year in the 0% long-term capital gains bracket, you’ll owe the government nothing on your stock sales. The only other way to avoid tax liability when you sell stock is to buy stocks in a tax-advantaged account. One way to avoid paying taxes on stock sales is to sell your shares at a loss.
Closing Thoughts
While losing money certainly isn’t ideal, losses you incur from selling stocks can be used to offset any profits you made from selling other stocks during the year. And, if your total capital losses exceed your total capital gains for the year, you can deduct as much as $3,000 of losses against your total income for the year.