Trading in and out of the market is expensive. Even
if we get lucky, a big hunk of our winnings will go to pay
capital gains taxes. Theres more truth than humor
in the old saw Investors drive Cadillacs, traders
- Barbara Stanny, author of
Prince Charming Isnt Coming:
How Women Get Smart About Money
Will Rogers once said, Baseball is Americas game--it,
and high taxes. That certainly underscores how much
taxes go hand-in-hand with the American way of living. However,
the more you know about what creates a tax liability, the
better you can prepare for and attempt to minimize taxes.
A dividend is the interest your stock earns when the company
makes a profit. Periodically a stock will distribute dividends
to its shareholders. Regardless of whether you receive a cash
dividend or have it automatically invested back into the stock,
the distribution is subject to your ordinary income tax rate at the federal level.
Short-Term Capital Gains
A short-term capital gain is the profit distributed when you
sell shares youve only owned for one year or less. Short-term
gains are subject to ordinary income tax rates.
Long-Term Capital Gains
A long-term capital gain is the profit distributed when you
sell shares youve owned for more than one year.
Capital gains may be taxed at 5, 15, 25 or 28 percent or a combination of rates, depending on your ordinary income tax rates and other factors. Visit www.irs.gov for details. These tax levels are known as long-term capital gains and apply to assets that you hold for at least 366 days (more than one year). The long-term capital gain tax generally is much lower than what you pay on your regular income.
Calculating Gains & Losses
When you sell shares, you generally incur either a gain or
loss. If your selling price is less than what you originally
paid, you incur a loss. Losses may be used as a deduction
against gains when filing your tax return.
Gains, on the other hand, occur when you sell shares for
more than you originally paid. Gains are subject to capital
To calculate your capital gains or losses, you must determine
the cost basis of the shares you own. The cost basis is the
original purchase price of the stock, and you determine your
tax liability through one of the three following calculation
- Average cost method
- Specific identification method
- First in, First Out (FIFO) method
Check with your financial advisor or accountant for the specifics
of each method.