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Taxes on stocks Explained – Short Term Capital Gains Tax

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Taxes on stocks Explained – Short Term Capital Gains Tax

Guide

Brian-

This article will go over the topic of taxes on stocks regarding the short-term capital gains tax.

I hope to make this topic as fun and entertaining as possible for you, while also helping educate you about taxes on stocks.

This article will focus on short term capital gains. I’ll write another article that goes over long term capital gains. In my opinion, short term capital gains tax is more exciting than the long term capital gains tax.

By the end of this article, you will:

  • understand what a short-term capital gain is vs. a long-term capital gain is
  • how much you’ll pay in taxes from short term capital gains
  • why this is important to understand in relation to the stock market
  • what you’ll need to do on your tax return

Let’s first answer the question: What is a short-term capital gain in the stock market?

If you buy a stock and sell that stock within one year, that would be considered a short-term capital gain.

Therefore, what makes a short-term capital gain a short-term capital gain is simply how long you held the stock for, it’s that easy. It’s as simple as looking at the date you purchased the stock and the date you sold the stock. If that holding period is shorter than a year and you sold the stock for a gain, it’s classified as a short-term capital gain

So here’s a Pop Quiz to see if you understand the concept:

You bought a stock, you held it for longer than a year, and then you sold it. Would that be considered a short-term capital gain or a long-term capital gain?

In that case, your gain would be a… long-term capital gain.

If bought a stock, held it for a year or less, and then you sold it. Then your gain would be a… short-term capital gain.

Pretty easy to understand, right?

Next Question: How much will you pay in taxes from your short-term capital gains?

The answer is that it depends on how much money you make.

Let me break this down for you, piece by piece:

The short-term capital gains tax rate is your regular, normal tax rate.

The long-term capital gains tax rate is a much better and favorable rate.

In other words, you get a tax advantage if you hold your stocks for longer than a year. If you don’t hold your stocks longer than a year before you sell, they are considered short term capital gains, and you do not get any of that favorable tax treatment.

It’s not that you get an unfavorable treatment with short-term capital gains, you’ll just get taxed at your regular, normal rates. The same rates that you get taxed for your regular income, like your W-2 income.

A couple asking a CPA about capital gains taxes

So what will your tax rate be on short term capital gains?

That will depend on which tax bracket you’ll be in, which depends on how much money you make.

We’re talking about your total income. That includes how much money you make from your job, self-employment, your stocks, everything.

If you make a lot of money, then you’ll be in a higher tax rate. If you don’t make much money, then you’ll be in a lower tax rate.

So you have to see what tax bracket you’re in, which is based on how much money you make, and that will be your tax rate for short term capital gains.

Here’s an easy to follow example.

Let’s say you’re in the 22% tax bracket. You bought Tesla stock for $400 and you sold it 1 month later for $500. You did not hold on to the stock for longer than a year, you only held it for a month, so it’s a short-term capital gain.

You’re going to pay short term capital gains tax on your profits. In this example, you bought the Tesla stock for $400 and sold it for $500. Your profit from the sale of the stock is $100.

If you’re in the 22% tax rate, then you’re going to pay $22 in short term capital gains tax. The equation would be to take you $100 of profit and multiply it by 22%.

It’s as simple as that!

Next Question: Why is this important to you in the stock market?

This is important to you in the stock market for many reasons.

I’ll give you one example.

Let’s say that you bought a really good stock and the price of the stock has continuously been increasing. You’ve been holding onto it for 11 months and you’re up a ton of money so you’re thinking about selling that stock.

Here’s the dilemma, do you want to sell now, before the one-year mark and pay much more taxes with a short term capital gain? Or do you want to risk holding it for 1 more month so that you can get the much more favorable long term capital gains tax treatment?

If you didn’t know about short term capital gains vs. long term capital gains, well, then you’re not armed with the proper knowledge to make a good decision. These are things that you need to take into consideration because the tax savings could be significant.

A chart of gains and losses

Last Question: What do you have to do on your tax return if you’ve been buying and selling stocks?

First of all, you don’t need to keep track of anything. Your brokerage keeps track of all the details for you. Brokerages like Robinhood, Webull , TD Ameritrade and the countless other brokerages out there track all of that information for you on every trade that you make.

Once the year comes to an end, you’ll need to file your taxes by April 15th. Before then, by February 15th, your brokerage will send you a tax document called the 1099-B. They’ll mail that to you or you can just download the 1099-B from your brokerage account.

The 1099-B tax form will tell you everything you need to report on your tax return. The 1099-B tax form will break down all your short-term capital gains, your long-term capital gains, your gains and losses, your dividends, and any other activity you did in your brokerage account.

Remember, they’ll provide that to you by February 15th, so make sure you don’t file your tax return before then and forget to include that information on your tax return.

That’s it. If you made it this far, hopefully I held up my end of the bargain and you understand the short-term capital gains tax better and how this impacts you in the stock market.

Please check back in our website as we post new articles frequently. Also, please subscribe to my YouTube channel: ClearValue Tax, where there are a lot of tax and personal finance videos. By subscribing, you can be notified when I’m broadcasting live and answering questions from subscribers.

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