The Tax Consequence for Trading Stock

Stock profits can result in a tax liability.

Stock profits can result in a tax liability.

Making money trading stocks can be hard to do. If you succeed, you've got another challenge -- figuring out how to calculate your taxes. The tax consequences of trading stocks can vary based on a number of factors, including how long you held your stocks and whether or not you've taken losses in the past. In any case, you need to report your trades to the Internal Revenue Service every year.

Short-Term Capital Gains

If you're a stock trader, most of your profits are likely to be short-term capital gains. A short-term gain, as defined by the IRS, is a profit on any capital asset, such as a stock, that you hold for one year or less. A short-term capital gain is taxable as "ordinary income," the same as your salary and wages. If you are in a high tax bracket, or if you take a lot of short-term gains in any given year, your taxes on trading stocks could be substantial.

Long-Term Capital Gains

Holding your stocks for the long term, rather than trading them frequently, can greatly ease your tax burden. If you hold stocks for longer than one year, your profits are taxed at the capital gains tax rate, which is more favorable than the ordinary income tax rate. For 2012, the top capital gains rate is 15 percent, versus the top ordinary income rate of 35 percent. If you are in the two lowest tax brackets, your capital gains rate drops all the way to zero percent.

Dividends

During the time you hold a stock, it might pay you a dividend, which is a share of the company's profits. Dividends are taxable, above and beyond any capital gains profits you later take. Most dividends are taxed as ordinary income, although some, known as qualified dividends, are taxed the same way as capital gains, with a top rate of 15 percent as of 2012.

Capital Losses

Although losing money isn't usually the objective of trading stocks, most traders will experience at loss at one point or another. A loss can help reduce your tax burden. The IRS allows you to use your losses to help offset any capital gains you have, reducing your tax burden. If you have no gains, or if your losses exceed your gains, you can use up to $3,000 to lower your taxable ordinary income for that year. Any additional losses can be carried forward indefinitely to offset gains in future years.

 

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