Taxes on Short-Term Equity

by Eric Bank, Demand Media Google
    Short-term tax rates are higher than long-term ones.

    Short-term tax rates are higher than long-term ones.

    When you buy stock shares, you have some "equity," or ownership, in the corporation that issued the shares. Stock prices go up and down, providing gains or losses to traders. Some equities pay dividends, which are cash payments to shareholders. An investment is short-term if you sell it within one year. The Internal Revenue Service taxes long-term investments at lower rates.

    Equity Types

    You can buy equity in the form of common stock and preferred stock. Common stock ownership gives you voting rights -- the voting majority decides who sits on the company’s board of directors. Common stock might pay dividends. Preferred stock always shells out a dividend, but doesn't provide voting rights. If a corporation goes bankrupt, it may be sold off in pieces to pay off investors. Lenders receive payment first, followed by holders of preferred shares and then common shareholders. Preferred stock dividends don’t change, which helps to keep the share price stable.

    Capital Gains and Losses

    The price you pay to buy shares is your “cost basis.” When you sell the shares, your profit or loss equals the sale amount minus the cost basis. The capital gains tax on short-term profits is equal to your ordinary tax rate, but long-term rates are lower. As of 2013, the long-term capital gains tax rates range from 20 percent to 0 percent, depending upon your gross income. You subtract capital losses from capital gains and from up to $3,000 of ordinary income. You can carry unused capital losses forward to reduce taxes in later years.

    Taxes on Dividends

    Most U.S. equities and many foreign ones pay “qualified” dividends that are taxed at long-term capital gains rates. As of 2013, if your modified adjusted gross income, or MAGI, is greater than $400,000 as an individual -- or $450,000 when you file a joint return -- your tax rate on qualified dividends is 20 percent. If your MAGI is lower, your qualified dividend tax rate is 15 percent when your ordinary tax rate is 25 percent or higher. Otherwise, the qualified dividends are tax-free. You fork over taxes at your ordinary rate on non-qualified dividends.

    Dividend Holding Periods

    Stocks that pay dividends usually do so quarterly. To take advantage of the lower tax rates on qualified dividends, you must hold the dividend-paying shares for at least 61 days surrounding the ex-dividend date. Stocks trade without the current dividend beginning on the ex-dividend date, which occurs a few weeks before the dividend payment date. You must own the shares at the close of trading on the day before the ex-dividend date to receive the dividend. The required holding period for preferred shares is 91 days if the dividend is paid for periods that exceed 366 days.

    About the Author

    Based in Chicago, Eric Bank has been writing business-related articles since 1985, and science articles since 2010. His articles have appeared in "PC Magazine" and on numerous websites. He holds a B.S. in biology and an M.B.A. from New York University. He also holds an M.S. in finance from DePaul University.

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