Stock investors buy shares with the hope of making significant profits on their investments. When profits are made, taxes are usually due on those profits. However, there can be some significant tax rate advantages to stock investments compared to other types of investments or income. Tax considerations should not drive stock buying and selling, but they should be kept in mind.
Dividends earned from many stocks qualify for lower income tax rates. Qualified dividends are paid by companies organized as regular corporations. Companies organized as a partnership or real estate trust usually do not pay qualified dividends. The tax rate on qualified dividends is zero percent if the investor's marginal income tax bracket is below 25 percent and the dividend tax rate is 15 percent for marginal tax brackets of 25 percent and higher.
An important consideration of stock investing is the ability to time when a taxable gain occurs. No taxes are due until a stock is sold for a profit. An investor has the option of holding shares for years, making huge profits and never paying taxes if the shares are not sold. If unsold stock shares are passed to a heir, the heir gets the shares with a cost basis of the share price at the time of the original owner's death. Passing appreciated stock to heirs allows the complete avoidance of any tax on the gains to that point.
Short and Long Term Gains
If stock shares are sold for a profit, the profit must be classified as either a short term or long term gain. Short term gains are realized from shares owned for one year or less. These gains are taxed at the investors regular income tax rate. Long term capital gains qualify for lower income tax rates. At the time of publication, the long term capital gain rates were the same rates as for qualified dividends, zero or 15 percent.
If stock shares are sold for a loss, the loss can be used as a write off against capital gains or other income. Stock losses are also divided into short term capital losses and long term capital losses. On an investor's income taxes, like losses are first used against like gains, then excess losses are used against the other category of gains. If total capital losses exceed total long and short term gains, the excess losses can be used to reduce other income.