The Tax on Investment Interest & Stock Gains

by Michael Dreiser, studioD

In the United States, the Internal Revenue Code requires that individual income taxpayers include both interest income from investments and gains from the sale of stock as part of taxable income when completing Internal Revenue Service Form 1040, U.S. Individual Income Tax Return. The tax rate and the timing of the recognition of income, however, differs between the two types of income.

Interest Income

In general, the Internal Revenue Code requires that interest income must be recognized as interest by an individual income taxpayer at the earliest point at which the interest is actually received or when the taxpayer is entitled to receive the interest without substantial cost or penalty. For interest-paying investments of a year or more, taxpayers must recognize interest, known as original issue discount, on the difference between the issue price of the investment and the face value of the investment. Original issue discount also applies to debt investments that do not pay interest until maturity, such as certificates of deposit. Individuals pay income tax on interest income at ordinary income tax rates, with the exception of interest earned on state and local debt obligations, which are generally not taxable for federal income tax purposes.

Stock Gains

Unlike interest income, where the income may be recognized by the taxpayer before constructively received, individual income taxpayers with gains from holding stock do not need to recognize the gain until the investment is realized. An investment is considered realized when actually sold or the taxpayer no longer holds the economic risk of ownership. For example, a taxpayer owning 100 shares of Company's ABC's stock would no longer experience the economic risk of ownership if he or her were to take a short position in an additional 100 shares of stock in Company ABC. Investors in stock can defer the recognition of gain by not selling stocks that have appreciated in value.

Stock Tax Rates

Long-term gains from the sale of stock and other capital assets are eligible for special, reduced capital gain rates. Long-term capital gain rates apply to stocks and other capital assets with a holding period of more than a year. As of publication, the long-term capital gains rate is 15 percent for taxpayers in ordinary marginal income tax brackets of 25 percent or greater. For taxpayers in ordinary marginal income tax brackets of less than 25 percent, the long-term capital gains rate is zero. Short-term capital gains (from a holding period of one year or less) do not qualify for special tax treatment and are taxable at full ordinary income tax rates -- the same rates applicable to interest income.


A portion of stock gains are paid to investors in the form of dividends. Dividends are periodic distributions of a company's assets (nearly always paid in cash). Dividends are generally recognizable as income by individual income taxpayers when they are paid. Certain dividends, known as qualified dividends, are eligible for taxation at the reduced long-term capital gain rates. Qualified dividends are generally dividends paid to taxpayers who have owned the stock for more than 60 days in the 121-day period beginning 60 days before the ex-dividend date. (The ex-dividend date is the first date following a company's declaration of a dividend that a stockholder will not receive the next dividend payment.)

About the Author

Michael Dreiser started writing professionally in 2010. He is a certified public accountant with experience working for a large New York City accountancy and expertise in areas ranging from private equity taxation to investment management. He holds a Master of Business Administration in international finance from l’École Nationale des Ponts et Chaussées in Paris.