When you sell an investment for more than you paid for it, then you typically have to pay capital gains tax on your profit. Federal tax law on capital gains applies to all U.S. taxpayers, but in Missouri, you'll also have to pay state tax on your capital gains, and the way the two systems work is somewhat different. Let's look more closely at the differences and how they affect Missouri taxpayers.
Federal capital gains tax
Capital gains are taxed in two different ways for federal tax purposes, depending on how long you held the investment. If you owned your investment for a year or less, then you'll pay short-term capital gains tax at rates equal to your ordinary income tax rate.
On the other hand, if you owned your investment for longer than a year, then long-term capital gains tax rates apply. For those in the lowest two federal tax brackets, no capital gains tax is imposed on long-term gains. A 15% maximum applies to those in the 25% federal bracket or higher, except that those in the highest 39.6% federal bracket pay a 20% maximum for long-term capital gains.
This preference for long-term capital gains has the impact of encouraging long-term investors. Those who trade frequently get penalized with higher rates.
Missouri capital gains tax
Capital gains get taxed for Missouri state income tax purposes in a much simpler manner. Missouri doesn't recognize any difference between long-term and short-term capital gains, and it doesn't have preferential rates that are tied to how long you hold onto an investment. Instead, all gains get taxed at whatever rate you'd pay on the rest of your income.
Missouri has a progressive tax system, but the brackets are extremely small. Even though Missouri has 10 tax brackets that start at just 1.5%, taxpayers pay a 6% tax rate on any Missouri taxable income above $9,000. For many investors, that means that Missouri adds a 6% tax burden to whatever they pay federally, and so calculating the tax just involves multiply your profit on your investment by 6%.
Be careful
Because of the combined liability from federal and state capital gains taxes, you should always think twice before choosing to sell an investment. Tax considerations alone shouldn't lead you to hold onto an investment that you want to sell for legitimate reasons, but if you think your investment still has good long-term prospects, it can be smart to not to sell and therefore to avoid having to pay any capital gains taxes at all.
This article is part of The Motley Fool's Knowledge Center, which was created based on the collected wisdom of a fantastic community of investors. We'd love to hear your questions, thoughts, and opinions on the Knowledge Center in general or this page in particular. Your input will help us help the world invest, better! Email us at knowledgecenter@fool.com. Thanks -- and Fool on!