How to Pay Capital Gains Taxes on Stocks

As a diligent, long-term saver, you might be sitting on top of hundreds of thousands, if not, millions of dollars in capital gains over the course of your lifetime. The tax man, of course, always stands at the ready to demand and take his pound of flesh.

Intelligent investors remain prescient of capital gains taxes, as a major component to subtract away from total returns. The Economic Growth and Tax Reconciliation Act of 2001 and Jobs and Growth Tax Reconciliation Act of 2003, colloquially known as the Bush Tax Cuts, still frame the investment tax code and conversation.

Realized Capital Gains

For now, it is only realized capital gains and losses that trigger taxable events. Capital gains are realized at the exact moment shares of stock are sold for a profit.

Going forward, legislators are likely to increasingly float ideas for a “wealth tax,” which would actually take levies from any market appreciation. At that time, unwitting investors might be slammed with outrageous tax bills simply for carrying larger accounts, right before a market crash.

Short and Long-Term Capital Gains

The IRS classifies capital gains according to time frame. Long-term capital gains are made on investments held for at least one year, before being sold.

Be further advised that mutual fund distributions are treated according to the time that the fund manager held specific investments within the fund, before selling, and not according to the timeline that you owned fund shares in the greater fund pool.

Similar to qualified dividends, long-term capital gains receive favorable tax treatment and are taxed at zero, 15%, and 20% rates. Single filers reporting between $41,675 and $459,750 ($83,350 and $517,200 for married filing jointly) will be taxed at the 15% rate.

Short-term capital gains, like ordinary dividends, are taxed at higher ordinary income rates. For 2023-2024, taxpayers will fall into seven separate brackets and pay taxes at 10%, 12%, 22%, 24%, 32%, 35%, and 37% rates.

Single filers raking in at least $578,126 ($693,751 for married filing jointly) for the year will occupy the highest 37% tax bracket.

The tax code is structured to encourage long-term saving and investing, rather than rapid-fire day trading.

Organize, Prepare, and File Tax Paperwork

Brokerages will prepare and file Form 1099-B – Proceeds from Broker and Barter Transactions both electronically to the IRS and to your address on record by January 31 for the prior tax year.

Form 1099-B will detail each trade cleared through the brokerage according to dates, cost basis, and gross proceeds.

Wash sales will be highlighted and omitted from any 1099-B capital loss calculations. Wash sales occur when traders sell shares at a loss and immediately buy back into that same investment within 30 days.

Form 1099-B information is entered directly into IRS Form 8949 – Sales and Other Dispositions of Capital Assets. Most importantly, Form 8949 categorizes trades according to short-term and long-term – to net out capital gains.

Here, we take realized short-term capital losses away from short-term capital gains and subtract realized long-term capital losses away from long-term capital gains to calculate net capital gains. Capital losses that exceed total capital gains may be written off – up to a $3,000 limit.

Schedule D will summarize Form 1099-B and 8949 information, by showing net short and long-term capital gains, or any realized capital losses. Losses that exceed the $3,000 cap may be carried forward – to be deducted in subsequent years.

Schedule D net capital gains (or losses) appear as a Form 1040 income line item. Lastly, we work through the Qualified Dividends and Capital Gains Tax worksheet to calculate the final tax bill.

Retirement Accounts

All retirement accounts offer the silver of tax deferral and the lead of severe tax penalties for violating The Code.

Savers will not owe taxes on dividends and capital gains as they occur within retirement accounts. Early withdrawals made before age 59 ½, however, are likely to trigger the 10% additional tax.

Traditional IRA, 403(b), and 401(k) account contributions are made with pre-tax money. All future distributions made from these accounts will be treated as ordinary income and taxed accordingly.

A Roth IRA is the mirror image of the Traditional IRA. Roth IRA withdrawals will be taken totally tax free at age 59 ½ because original contributions have already been taxed. Roth IRAs are especially ideal for young professionals, who expect to eventually retire at higher tax brackets.

Investment Strategy

At Onyx Investments, our ultimate goal remains to generate alpha returns for the least amount of financial risk. Making money on stocks does not always translate into a minimal tax bill.

Onyx would much rather pay capital gains taxes on a story stock – than to bitterly cling onto a losing trade with the misguided intent of ultimately writing off realized capital losses from taxable income.