It's not illegal to sell stock after owning it less than a year, so if you do so, no alarm bells are going to go off, and you won't have securities regulators knocking on your door at 3 a.m. But that's not to say there isn't a penalty. It comes at tax time and it comes in the form of a missed opportunity to reduce or even eliminate the tax on your profit.
Capital Gains Taxes
The tax code treats money differently -- meaning, the government takes more or less of it -- depending on where it comes from. If you make $3,000 from a job, for example, that's ordinary income, and you pay income taxes on it. If you make a $3,000 profit from selling stock, that's a capital gain. Depending on how much ordinary income you have, how long you owned the stock before you sold it and, perhaps most important, what Congress has been up to lately, the tax rate you pay on your capital gains could be substantially lower than your income tax rate -- and you might not pay anything at all.
Capital gains are classified as either short term or long term, based on how long you owned the stock. The cutoff is one year. If you held the stock for a year or less, your gain is short-term. In that case, the government taxes it as if it were ordinary income. That means the rate you pay is the rate of your tax bracket. As of 2012, the federal tax system had six brackets: 10 percent, 15 percent, 25 percent, 28 percent, 33 percent and 35 percent. If you were in the 10 percent income tax bracket, then you'd pay a 10 percent tax on your short-term capital gain. If you're in the 15 percent bracket, you'd pay 15 percent on short-term gains, and so on. At this point, that might not really look like a penalty, but just wait.
If you held the stock for more than a year, your gain is long term. Although capital gains tax rates have historically jumped all over the place, long-term rates are usually significantly lower than short-term rates. That's because the whole point of taxing capital gains at a lower rate than ordinary income is to encourage investment -- specifically, long-term investment. As of 2012, people in the lowest two brackets, 10 percent and 15 percent, paid no tax on long-term capital gains -- as in 0 percent, zilch, nothing. For the hypothetical $3,000 stock profit discussed earlier, the difference between short-term and long-term gains amounted to $300 in tax savings for those in the 10 percent bracket and $450 in the 15 percent bracket. Taxpayers in the other four brackets, meanwhile, all paid just 15 percent on long-term gains. For them, the savings on that $3,000 profit ranged from $300 in the 25 percent bracket to $600 in the 35 percent bracket. Congress, of course, can change the rates at any time, but expect long-term rates to remain lower than short-term rates.
Up to this point, the assumption has been that the stock you're selling is not restricted stock. Companies often distribute stock to employees and others as rewards or compensation, on the condition that the recipients hold on to the stock for a certain amount of time. If your stock is restricted like this, you might not be able to sell it at all in the first year. You probably couldn't even if you tried, since the company won't release it to you until you're vested, meaning the restrictions have passed and the stock is yours for good.