Income Tax Rate on Common Stock Gains

Long-term gains on common stock get preferred tax treatment.

Long-term gains on common stock get preferred tax treatment.

Common stock refers to shares of ownership issued by corporations. Owners of common stock generally have voting rights -- of one vote per share owned -- but are at the bottom of the pecking order for receiving assets should the company go bankrupt. Your gains from the sale of common stock are figured by subtracting your purchase price per share plus investment expenses, such as broker commissions, from the selling price.

When Gains are Taxable

When you own common stock, the price fluctuates daily, so some days you'll have gains while others you'll have losses. However, for income tax purposes, it doesn't matter how much the price of the stock increases or decreases while you own the stock. Instead, you only recognize gains and losses for tax purposes when you actually sell the stock or when the stock pays a dividend. For example, if you paid $1,400 to acquire stock and the value increased to $2,000, you wouldn't have any taxable income unless you sold the stock at the higher price. However, if you later sell the stock for $1,800, you must record a gain of $400.

Holding Period

How long you've owned the common stock makes all the difference when determining the applicable tax rates. If you hold the common stock for one year or less, your profit from its sale is treated as a short-term capital gain. If you hold the stock for more than a year, the income is treated as a long-term capital gain. When figuring your holding period for the common stock, don't count the day you bought the stock, but do include the day you sold the stock.

Different Tax Rates

The IRS taxes short-term capital gains at ordinary income tax rates, which are the same rates that you pay on other income such as wages or interest income. As of 2012, these rates go as high as 35 percent. For long-term capital gains, the maximum rate as of 2012 is only 15 percent. The fact that the long-term capital gains rates are 20 percent less than the maximum ordinary income tax rate give you a significant tax incentive to hold the stock for more than one year to lower the tax rate you pay on the gains.

Tax Treatment of Dividends

Similar to the gains from the sale of common stocks, a dividend has two applicable tax rates, depending on whether it is a qualified dividend. To be a qualified dividend, it must be paid by a U.S. corporation or a qualified foreign corporation. In addition, you must have owned the stock for at least 60 days between the 60 days before and the 60 days after the ex-dividend date. If you receive a qualified dividend, it is taxed at the lower long-term capital gains rates. Non-qualified dividends are taxed at the higher ordinary income tax rates.

About the Author

Mark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."

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