What Are the Tax Consequences of Selling Stock?

Among all of the asset classes, many investors favor stocks due to convenience and high liquidity. Investors with various investment budgets can participate in stock markets. Also, there is less work involved to acquire or sell a stock compared to other assets. However, you have to pay taxes on your profits when you sell stocks. 

If you are selling the stock within a year, it will be considered a short-term gain and taxed as ordinary income. Short-term capital gains will not get any benefits on the tax front. The gains will be taxed under one of the seven rates between 10 percent and 37 percent.  

In contrast, if you had held the stock for more than one year, it will be considered a long-term capital gain. Long-term capital gains are taxed at favorable rates.

The tax rate on a long-term capital gain will be decided based on investors’ status and capital gains. These tax brackets and rate change each year. The rates given below are for 2020. 

If a single person's gains are less than $40,000, they will not be taxed. The profits from $40,000 to $441,450 will be taxed at 15 percent, while profits above $441,450 will be taxed 20 percent.

If the person is the head of a household, the profits will not be taxed up to $53,600. The capital gains from $53,600 to $469,050 will be taxed at 15 percent, while capital gains above $469,050 will be taxed 20 percent.  

If the person is married and files their taxes separately, then the capital gains will not be taxed up to $40,000. However, the person will be taxed 15 percent on profits from $40,000 to $248,300. Capital gains above $248,300 will be taxed 20 percent. 

If the person is married and filing taxes their partner, then capital gains up to $80,000 will not be taxed. However, profits above $80,000 to $496,600 will be taxed at 15 percent, while profits above $496,600 will be taxed 20 percent. 

If a single person's adjusted gross income exceeds $200,000, they will incur an additional 3.8 percent of taxes. For married couples filing jointly, if the gross income exceeds $250,000, they incur an additional 3.8 percent of taxes. 

There are a few ways that you can avoid paying income taxes. If you are single and your income is below $40,125, then your capital gains will not be taxed as long as your capital gains and other income are below that value. If you are married and filing your taxes jointly, then the amount is $80,250. Financial planning can help reduce your tax burden.

The second method is utilizing your capital losses to offset capital gains. In a given year, you are allowed only to offset $3,000 of your capital gains. However, you are allowed to carry forward the remaining losses to the next year. 

The third method involves donating the stocks directly to qualifying charitable organizations. You will receive a tax deduction for the full market value of the donated stocks. 

The Tax Cuts and Jobs Act allows investors to place their investments with unrealized capital gains in an opportunity fund for tax benefits. For investors, the taxes on the capital gains will be deferred until 2026 or when the investor decides to sell the stake.

If the investor holds the investment with capital gains in the opportunity fund for five years or more, then the investor will only have to pay tax on 90 percent of its capital tax gain. Meanwhile, if the investment is held for seven years or more, then only 85 percent of the capital gain will be taxed.

If the investor holds the asset in the fund for over 10 years, then the investor will not have to pay any tax on the capital gains generated from the investment in the opportunity fund. 

Under the dividends reinvestment plan, some companies give existing shareholders an option to reinvest their cash dividends by buying additional shares. These additional shares will be issued directly by the company. So, investors will not incur commission charges. 

Even though the shareholder does not receive the reinvested dividends, investors must report that under taxable income.