If you're on a Galaxy Fold, consider unfolding your phone or viewing it in full screen to best optimize your experience.
There's a lot for new investors to learn, such as how to choose and open a brokerage account. But one thing often overlooked by beginning investors -- and even some experienced ones -- is how investing and taxes work.
Knowing which investments are taxed (and which are not) is important. How you navigate the intersection of investing and taxes matters, as it can change your profits. Here's a primer on the basics to help you get started.
Here's the first thing you should know about investing and taxes as a new investor: If you own a stock and the price goes up, you don't have to pay any taxes.
In the United States, you only pay taxes on investments that increase in value if you sell them. In other words, the government taxes your profits, not your holdings.
Consider this: Warren Buffett owns more than $100 billion in Berkshire Hathaway stock, and he's never paid a dime in taxes on any of his shares. How? Because he's never sold them.
The profit you make when you sell an asset is called a capital gain. Capital gain happens when you buy a stock or other investment at one price and later sell it at a higher price.
For example, if you buy stock for $2,000 and sell it for $2,500, you have a $500 capital gain. That gain is subject to federal taxes.
Capital gains taxes apply if you profit from the sale of most investment types. These include bonds, mutual funds, ETFs, precious metals, cryptocurrencies, and collectibles. Even real estate sold at a profit can be considered a capital gain, though the rules are a bit more complicated.
The IRS splits capital gains into two main categories: long term and short term.
For example, if you bought a stock on Jan. 1, 2020 and sold it on Jan. 2, 2021, you owned it for more than a year. Any resulting profit is taxed as a long-term capital gain. On the other hand, if you bought a stock on Jan. 1, 2020 and sold it on Jan. 1, 2021, you owned it for less than a year, so it's taxed as a short-term gain.
As you'll see in the next couple sections, long- and short-term capital gains are taxed differently.
READ MORE: Best Stock Brokers for Beginners
Profit from selling an investment you've held for over a year is taxed according to the IRS' long-term capital gains tax rates. Those rates are 0%, 15%, or 20%, depending on your total taxable income.
Here's a quick look at the long-term capital gains tax rates for the 2023 tax year (the tax return you'll file in 2024):
Tax filing status | 0% rate | 15% rate | 20% rate |
---|---|---|---|
Single | Taxable income of up to $44,625 | $44,626 to $492,300 | Over $492,300 |
Married filing jointly | Taxable income of up to $89,250 | $89,251 to $553,850 | Over $553,850 |
Married filing separately | Taxable income of up to $44,625 | $44,626 to $276,900 | Over $276,900 |
Head of household | Taxable income of up to $59,750 | $59,751 to $523,050 | Over $523,050 |
In addition to the rates listed in the table, higher-income taxpayers may also pay a 3.8% net investment income tax. This applies to any investment income, not just capital gains. Dividends, interest income, rental income from real estate, and passive business income counts toward your net investment income.
As with most things investing and taxes, the taxable limit depends on your filing status. If you are a married couple filing jointly with adjusted gross income of more than $250,000, your investment income above that threshold is taxed. If you're married and file separately, the threshold drops to $125,000. For single, unmarried, or head-of-household filers, the threshold for the additional tax is an adjusted gross income of $200,000.
Only income above the threshold is subject to the net investment income tax. For example, if you and your spouse earn $200,000 from your jobs and $70,000 from your investments, only the $20,000 that makes your income exceed the threshold may be taxed at 3.8%.
Uncover the names of the select brokers that landed a spot on Motley Fool Money's shortlist for the best online stock brokers. Our top picks pack in valuable perks, including some that offer $0 commissions and big bonuses.
Long-term capital gains receive favorable tax treatment, but short-term gains do not. If you earn a profit on an investment that you hold for a year or less, it is taxed using the same tax brackets as ordinary income.
This means short-term gains are typically taxed at a higher rate than long-term gains.
For reference, here are the 2023 U.S. tax brackets that apply to short-term capital gains:
Tax Rate | Single Filers | Married Filing Jointly | Heads of Households |
---|---|---|---|
10% | $0 to $11,000 | $0 to $22,000 | $0 to $15,700 |
12% | $11,001 to $44,725 | $22,001 to $89,450 | $15,701 to $59,850 |
22% | $44,726 to $95,375 | $89,451 to $190,750 | $59,851 to $95,350 |
24% | $95,376 to $182,100 | $190,751 to $364,200 | $95,351 to $182,100 |
32% | $182,101 to $231,250 | $364,201 to $462,500 | $182,101 to $231,250 |
35% | $231,251 to $578,125 | $462,501 to $693,750 | $231,251 to $578,100 |
37% | Over $578,125 | Over $693,750 | Over $578,100 |
Sometimes, you may not have any gains when you sell investments. In some cases, you may even find yourself with capital losses.
You can use capital losses to reduce your capital gains. In other words, if you sell a stock at a $5,000 profit but sell another stock at a $1,000 loss, your taxable capital gain for the year is $4,000.
You must use long-term capital losses to offset long-term gains before applying them toward short-term capital gains. Similarly, you must use short-term losses to reduce short-term before long-term gains.
If your capital losses are greater than your capital gains in a given year, you can use them to offset your other taxable income. This deduction is capped at $3,000 per tax year (or $1,500 if married and filing separately). However, if your net capital losses exceed the capped amount, you can carry them over to subsequent years.
Capital gains and losses aren't the only important part of investing and taxes. Dividends (earnings distributed by companies to shareholders) are also taxed, at a rate depending on the classification.
Just as with capital gains taxes, dividends have two basic classifications for tax purposes: qualified dividends and ordinary dividends. Qualified dividends are taxed at the long-term capital gains rates. Ordinary dividends are taxed like ordinary income.
To be considered a qualified dividend, two basic requirements must be met:
Some dividends are never considered "qualified." These include dividends from tax-exempt organizations, capital gains distributions, dividends paid on bank deposits (for example, credit unions often pay dividends on deposit accounts), and dividends paid by a company on stock held in an employee stock ownership plan (ESOP).
In addition, dividends paid by pass-through entities, such as real estate investment trusts, or REITs, are typically considered ordinary dividends, although there are exceptions.
The final type of income to note for investing and taxes is interest income, which is typically taxed as ordinary income. This includes interest payments you receive on bonds, ETFs, mutual funds, checking and savings accounts, and certificates of deposit (CDs). If your brokerage pays you interest on cash balances, this, too, is taxed as ordinary income.
One big exception is municipal bonds, which are bonds issued by states, cities, and localities. Generally speaking, municipal bond interest is not taxed by the federal government.
An important distinction to make regarding investing and taxes is the difference between a standard (taxable) brokerage account and an individual retirement account, or IRA.
The rules for investing and taxes we've laid out here only apply to investments held in a taxable brokerage account. IRAs allow you to invest on a tax-deferred basis.
In other words, you don't pay capital gains taxes on the sale of profitable investments or on dividends received through an IRA. Additionally, you don't need to report interest income you receive in your IRA.
There are two kinds of individual retirement accounts: traditional and Roth.
When choosing between the two, consider tax advantages and withdrawal flexibility. That'll help you decide which account may save you more money over the long run.
All IRAs have some excellent tax advantages over standard brokerage accounts. The trade-off is that you usually leave your money in an IRA until you're at least 59½ years old (with a few exceptions).
$0 stock, ETF, and Schwab Mutual Fund OneSource® trades. No fees to buy fractional shares.
$0
Charles Schwab pioneered the low-cost brokerage model decades ago, and that legacy continues with its lineup of no-commission-fee offerings. The robust lineup of account types, investment vehicles, and high quality app round out the stacked feature set.
On Charles Schwab's Secure Website.
$0 for stocks, $0 for options contracts
$0
This brokerage is a clear standout for its well-rated mobile app and also has unique investment offerings like IPOs, options, and fractional shares.
On SoFi Invest's Secure Website.
$0 commission for online U.S. stock and ETFs*. No account fees****.
$0****
Fidelity makes investing easy with $0 commission trades, powerful tools, and 24/7 support. Trade stocks, ETFs, options, and even crypto -- all in one place. Get expert insights, automate your investing, and potentially earn more on uninvested cash.
On Fidelity's Secure Website.
No. In the United States, you only pay taxes on investments you sell. Put another way, you don't pay taxes on stocks you hold within a brokerage account. But once you sell those stocks, you will be taxed for capital gains.
Investments you hold for more than a year and sell at a profit are considered long-term capital gains and taxed at 0%, 15%, or 20% rates. Shorter investments are considered short-term gains and taxed as ordinary income. Exceptions exist, but most investment types follow these rules.
See disclosures: https://www.sofi.com/invest/
Fidelity disclosure
Investing involves risk, including risk of loss
* - $0.00 commission applies to online U.S. equity trades and exchange-traded funds (ETFs) in a Fidelity retail account only for Fidelity Brokerage Services LLC retail clients. Sell orders are subject to an activity assessment fee (historically from $0.01 to $0.03 per $1,000 of principal). Other exclusions and conditions may apply. A limited number of ETFs are subject to a transaction-based service fee of $100. See full list at Fidelity.com/commissions. Employee equity compensation transactions and accounts managed by advisors or intermediaries through Fidelity Institutional® are subject to different commission schedules.
**Fidelity Crypto® is offered by Fidelity Digital Assets®. Investing involves risk, including risk of total loss. Crypto as an asset class is highly volatile, can become illiquid at any time, and is for investors with a high risk tolerance. Crypto may also be more susceptible to market manipulation than securities. Crypto is not insured by the Federal Deposit Insurance Corporation or the Securities Investor Protection Corporation. Investors in crypto do not benefit from the same regulatory protections applicable to registered securities. Fidelity Crypto® accounts and custody and trading of crypto in such accounts are provided by Fidelity Digital Asset Services, LLC, which is chartered as a limited purpose trust company by the New York State Department of Financial Services to engage in virtual currency business (NMLS ID 1773897). Brokerage services in support of securities trading are provided by Fidelity Brokerage Services LLC (“FBS”), and related custody services are provided by National Financial Services LLC (“NFS”), each a registered broker-dealer and member NYSE and SIPC. Neither FBS nor NFS offer crypto as a direct investment nor provide trading or custody services for such assets. Fidelity Crypto and Fidelity Digital Assets are registered service marks of FMR LLC.
***Options trading entails significant risk and is not appropriate for all investors. Certain complex options strategies carry additional risk. Before trading options, please read Characteristics and Risks of Standardized Options. Supporting documentation for any claims, if applicable, will be furnished upon request.
****Zero account minimums and zero account fees apply to retail brokerage accounts only. Expenses charged by investments (e.g., funds, managed accounts, and certain HSAs) and commissions, interest charges, or other expenses for transactions may still apply. See Fidelity.com/commissions for further details.