If you invest in the stock market, there’s a good chance you have some questions about if you have to pay taxes on your stocks. No one looks forward to tax season and the additional complication of investment taxes can make the entire process seem quite stressful. However, there are ways to save money on your taxes.
Top 13 Tax Tips for Stock Investors
Although paying the least amount of money possible on your taxes should never be the primary motivation of your investment strategy, it never hurts to minimize the cut you’ll have to give the Internal Revenue Service (IRS).
Here are some of the top tax tips for investors to keep taxes at a minimum, which will take some preparation, record-keeping, and savviness.
1) Hold Your Stocks at Least Longer Than a Year to Lower Your Capital Gains Tax Rate
If you buy a stock for $1 and sell it for $3 then you have a capital gain of $2 on which you’ll need to pay taxes. However, capital gains tax rates vary depending on how long you’ve held your investment.
If you’ve owned the assets for one year or less, any profits you make are short-term capital gains. Short-term capital gains usually are taxed at the same tax rate (up to 37%) as your ordinary income when you file your taxes.
However, let’s say you’ve held onto the stocks for longer than a year. In that case, any profit from the sale would be considered long-term capital gains, which have much lower maximum tax rates, of up to 20% instead of 37%. Again, capital gains tax rates depend on your tax bracket, so be sure to determine which rate applies to your income level to avoid paying more than necessary.
For 2021 and 2022, long-term capital gains tax rates are 0%, 15%, or 20%, depending on your filing status and the amount of taxable income you have. Short-term capital gains are taxed as ordinary income.
What Qualifies as Capital Assets?
Although the primary focus of this article is paying taxes on stocks, they aren’t the only type of investments and assets that are subject to capital gains taxes. The IRS will also tax certain assets, known as capital assets, under the capital gains tax.
Examples of these assets include:
- Stocks and securities
- Household furnishings
- Coin collections
- Stamp collection
- Precious metals
- Jewelry and gemstones
Conversely, non-capital assets are not subject to short- or long-term capital gains taxes. Examples of non-capital assets include:
- Real estate that you use in your profession as a rental property
- Business inventory (i.e., a restaurant’s food inventory or a retailer’s clothing inventory)
- Accounts receivable that you receive during normal business operations
- Business property that depreciates in value
- Manuscripts, letters, speeches, drawings, and photographs
- Copyrights, patents, inventions, or models
2) Complete an Educated Projection of Your Taxable Income
A great way to minimize potential tax liabilities on your stock market investments is to make a projection of the tax obligations that may result from a transaction beforehand. By taking the time to calculate your capital gains or losses, dividends earned, and projected rates, you can stay prepared during the tax year and avoid major surprises when April rolls around.
In addition, completing a taxable income projection allows you to plan your tax strategy more effectively. If you’re unsure of your usual income tax rate or have no experience calculating taxes, don’t worry. TurboTax Premier will help you easily and accurately report your stock and crypto transactions and your gains and losses.
If you sold any stocks or crypto or you are planning to sell TurboTax has two great calculators that will help you understand the impact that transactions may have on your taxes. Check out their Cryptocurrency Tax Calculator and their Capital Gains Tax Calculator
3) Work with a Tax Professional
Working with a tax professional could help you minimize your obligation when it comes to paying taxes on stocks. A certified public accountant or tax advisor can offer you expert advice on how all of your investments fit together and assist with analyzing your most important tax documents. TurboTax Premier is an excellent choice whether you invest in stocks, real estate, and even crypto. TurboTax Premier can easily and accurately help you report your investment transactions, particularly your gains and losses. With TurboTax Live Premier you can get help along the way from a tax expert or have them fully do your taxes for you.
In addition, TurboTax offers secure services, guaranteed support in the event of a tax audit, and thousands of positive reviews from customers. If the IRS penalizes you because of a calculation error, TurboTax will pay it back—plus interest.
TurboTax offers a service that connects you with tax experts called TurboTax Live. This service has two levels, one that provides help along the way and one where you can fully hand over your taxes. With TurboTax Live Premier and TurboTax Live Premier Full Service you are matched with a tax expert experienced in investments
With TurboTax Live Premier, you can file your taxes with unlimited support from a tax expert. They will also review your return before you file for additional confidence. This is perfect for someone who wants to DIY their taxes, but still wants help with any questions that arise.
With TurboTax Live Premier Full Service, you get access to tax experts that will do your taxes for you. You simply upload your documents and your dedicated tax expert will take care of the rest. When you use TurboTax Live you can get access to a TurboTax Live tax expert in English and Spanish year-round. With TurboTax Live Full Service you are also able to get the same dedicated tax expert every year.
4) Familiarize Yourself with the Rules on Stock Dividends
Dividends are the most common type of distributions from a company. Dividends are classified as either ordinary dividends or qualified dividends. Ordinary dividends are taxable as ordinary income while qualified dividends that meet certain requirements are taxed at lower capital gain rates. If the company is a regulated investment company (RIC) (think mutual funds, exchange traded funds, or money market funds) or a real estate investment trust (REIT) it may pay capital gain distributions. The capital gain distributions are reported as long-term capital gains. Generally, if the company that holds your stocks is American or in a country that has a double-taxation treaty with America, you can get a break as a shareholder. Any capital gains you receive from those qualified dividends are eligible for a maximum tax rate of 20%.
On the other hand, non-qualified dividends (generally those from companies that aren’t in the U.S. or another qualifying foreign country) that pay non-qualified dividends are subject to the ordinary income tax rate, which is usually higher.
However, once again, the IRS puts requirements on ordinary dividends. You can only get the lower tax rate if you have held your stocks for over 61 days, and those days must have taken place two months before the ex-dividend date and during a 121-day period. You may be able to reduce your tax liability by holding your foreign assets in a tax-deferred account like a Roth IRA and U.S. stocks in a regular brokerage account.
5) Offset Capital Gains with Capital Losses to Lower Your Tax Obligation
Even the savviest investors can lose money trading in the stock market. Fortunately, you can use every capital loss to your advantage and offset gains to reduce the amount you’ll have to pay.
However, first, you’ll need to match your long-term capital losses to offset long-term capital gains and short-term capital losses to offset your short-term capital gains. Any capital asset you sell for more than what you initially paid will be a capital gain.
If you still have capital losses after you’ve calculated short-term and long-term capital gains for the tax year, you can use them to offset your ordinary taxable income. You can offset regular income, like interest or salary, with capital losses of up to $3,000. If your capital losses surpass your gains by more than $3,000, you can rollover any remaining losses into the following tax year. If you’re married but filing separately, each spouse can use up to $1,500 of net losses.
6) Use Tax-Loss Harvesting
Tax-loss harvesting is a great way to minimize your capital gains tax obligation, but it only applies to taxable investment accounts, not tax-free or tax-deferred accounts.
Shareholders with stocks that fall below the initial cost basis can sell them at a loss to minimize the impact of their gains for the current tax year. In effect, this reduces the amount of taxable income they would owe. In addition, the IRS does not permit deducting the losses from selling your stocks against capital gains from the same stock within 30 days before or after the sale date, which is called a wash sale. Harvesting tax losses is effective, but it shouldn’t be the primary strategy for your investments.
Read more: A Guide to Tax Loss Harvesting
7) Take Advantage of Tax-Advantaged Retirement Accounts
If you plan to trade stocks, you may have to pay capital gains tax. Fortunately, you have a range of options in the form of tax-deferred accounts (retirement accounts like a traditional IRA), which can allow you to defer or even avoid paying taxes on the growth of your money.
With a tax-deferred account, you don’t have to pay taxes on any growth until you withdraw your money. You can completely defer your tax bill on those accounts for multiple years, as long as the money stays inside the account. Here are some examples of retirement accounts you can invest in to minimize your taxable income:
- Roth IRAs
- Traditional IRAs
- Variable annuities
- Fixed deferred annuities
- Whole life insurance
- EE Bonds or I Bonds
8) Reinvest Your Dividends
If you want a way to reduce the amount of taxes you’ll have to pay, opt to reinvest your dividends, rather than taking the cash. Remember, the IRS treats ordinary dividends as a short-term capital gain.
However, if you reinvest those dividends by purchasing more shares in the company. In that case, you can qualify for a lower long-term capital gains tax rate and reduce your overall tax liability by reinvesting those capital assets.
Read more: 3 Tools to Calculate Your Net Worth
9) Ensure Correct Calculations on Capital Gains Taxes
Capital gains tax rates have a direct impact on your tax bills. If you can’t correctly calculate and analyze your return and accompanying tax forms to maximize every single tax deduction available to you, you’ll inevitably end up overpaying.
A critical factor in ensuring that you don’t end up giving the IRS a larger cut than necessary on your tax return is keeping meticulous records concerning your stocks and other investments. Every time you invest money, it’s crucial to record the details accurately. Even a minor error could end up costing you thousands of dollars. With TurboTax Premier you can directly import up to 10,000 stock transactions and up to 4,000 cryptocurrency transactions at once eliminating manual entry.
10) Deduct Trading Activities Expenses from Your Taxes
Some people forget that it costs money to purchase stocks from their investment brokerage firm. Not only do investors have to pay commissions and transactions fees, but if they change brokerages, they may also be subject to transfer fees.
The IRS won’t permit you to write off commissions and brokerage fees when purchasing and selling stocks. However, you can add those costs to the total amount you paid for a stock when calculating the cost basis. The fees may only be $10 here and there, but it adds up quickly. Every little bit helps!
11) Consider Tax-Friendly Investments
You can also consider diversifying your portfolio with tax-friendly investments. Although many investors look to corporate bonds due to their high rates of return, consider municipal bonds (munis) or U.S. savings bonds. The IRS doesn’t require you to claim the interest you earned on munis for your federal tax return, and U.S. savings bonds are exempt from state income taxes.
However, take the time to consider your tax bracket before you determine which bonds you want to add to your portfolio. If you earn a lot of money, municipal bonds are ideal. If you’re in the lower bracket, consider corporate bonds since they have a higher return rate.
12) Open a Health Savings Account
If you have a qualifying high deductible health insurance plan, then utilizing a health savings account (HSA) for your medical expenses is a great idea.
Your contributions are deductible, the money grows tax-free, and can be spent tax-free on qualifying health purchases. You can invest your funds via your HSA.
HSAs are a great choice because you can keep investing in them until you officially sign up for Medicare.
Read more: The Best Health Savings Accounts
13) Determine Your Sale Strategy: FIFO or LIFO?
Another vital consideration when paying taxes on stocks is what method you’ll use when selling your investments. Most investors choose the LIFO method: Last In, First Out. With the LIFO method, if they want to lower the amount of gain they recognize since selling later purchased stock will probably create a smaller gain. If you so choose LIFO, you may have a short-term gain and pay higher tax rates since you will have held the stock for a shorter period of time.
If you choose FIFO you’ll have a much higher chance of getting the lowest possible long-term capital gains tax rate instead of paying the higher short-term rate since you will have held onto the stock for a longer period of time before selling In addition, you can also designate specific shares you want to sell, or you can use the average cost per share when calculating your cost basis.
If you don’t specify FIFO or LIFO when you sell, the IRS will automatically treat your sales as FIFO transactions so you have to make sure your broker knows which methods you want to use.
Paying Taxes on Stocks: The Best Tips for Investors
Benjamin Franklin said it best: “In this world, nothing is certain except death and taxes.” You’re subject to certain taxes that can take a big bite out of your yearly income as an investor. However, with all the tips we just listed for paying taxes on stocks, you can minimize the amount of taxable income you’ll have to pay taxes on for the year. Diversify your portfolio by investing in tax-deferred accounts, reinvesting your dividends, and keeping your stocks for as long as possible before you sell.
Unfortunately, not everybody is a financial whiz or tax genius. Nevertheless, ensuring that you have correctly calculated your losses, gains, and taxable income is critical if you want to avoid overpaying. To ensure accuracy on their tax return, many people use tax software or work directly with a tax expert, like the tax experts at TurboTax.
Not only have hard-working Americans trusted TurboTax for over 30 years, but the company has the #1 tax software in the United States. Regardless of which tax professionals you prefer to work with, the help of a tax expert is invaluable. TurboTax Live tax experts can help you find every possible deduction and credit and help you offset your gains for the year and keep more of that hard-earned money in your pocket.