Investing in the stock market represents an opportunity to make profits as the businesses you buy into grow in size and value. However, profits from stock also mean higher income taxes at the end of the year. Investors must pay taxes on both the income they receive while they hold stock, and the profits they make when they sell it.
One form that stock profits take is investment income during the time that an investor holds stock. This income comes in the form of dividends, which some companies pay to their shareholders. Dividends are taxable and the companies that issue them send 1099-DIV forms to shareholders, who use the data on the forms to claim their profits as income on federal and state tax returns.
The other major type of stock profit arises when an investor sells stock for a higher price than it initially cost. In these cases, investors must claim their profits as capital gains. To figure capital gains, taxpayers must complete an additional tax form known as Schedule D. In this form, a taxpayer subtracts the cost of stock, known as the cost basis, from the net proceeds from the sale. This ensures that taxpayers are only liable for the profits they make, not the full amount of money they receive for stock sales.
Investment expenses count against a taxpayers profits from selling stock. For example, if you spend $500 going to a financial adviser, you can subtract that amount as an investment expense deduction from the value of your capital gains. In this example, if the stock earns you $5,000, but cost you $3,000 to buy, your taxable profit is only $1,500. Taxpayers must account for their investment expense deductions and show proof of expenses.
Capital losses, which are the opposite of capital gains, also have tax implications for investors. Capital losses reduce your taxable income just as capital gains add to it. This means that if you sell stock for a profit, you can minimize the amount you owe by also selling stock for a loss. You can write off up to $3,000 a year in capital losses. If you lose more than this, the excess amount can be carried over to future years.
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