Stock Tax Information
You absolutely need to pay taxes on stocks--under certain conditions. The IRS requires that taxes be paid on all kinds of income, including income derived from stocks, no matter their source. This means that taxes must be paid not only on profit from stocks an investor buys, but also on profit from stocks that are granted as part of employee benefit programs and stocks that are inherited from family members.
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Stock Taxes and Capital Gains
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Stock taxes must be paid anytime that the investor realizes a profit from the stocks, including many forms of dividends. Capital gains is the term used to describe the profit realized when a savvy investor sells stocks at a higher price than their value when the shares were first bought. A capital loss can actually reduce the amount of taxes an investor must pay, but a capital gain is usually taxed at 15 percent for most dividends and long-term capital gains held for longer than one year, while capital gains on stocks held less than one year are taxed at ordinary income levels, as much as 35 percent.
Specific ID
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Stock taxes can become very complicated when the investor sells a number of shares from the same company that were purchased at different times and for different base prices. Specific ID selling is a method of designating specific shares to sell to manage taxes. Selling high-cost shares first can reduce tax bills, or waiting on some stocks that have been owned less than a year while selling other long-term stocks can help investors save money on taxes.
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FIFO
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The other method of selling and computing taxes on stocks is known as FIFO, a popular business term short for First In, First Out. In other words, investors must sell the shares they acquired earliest, which can lead to higher taxes because they tend to be worth more than later shares. FIFO is desirable in a market where stock prices are falling, but undesirable when prices have been on the rise.
Avoiding High Taxes
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High capital gains taxes can generally be minimized if the investor follows certain basic strategies. Investors should avoid frequent trading to lower taxes. The longer the shares are held, the better taxes will tend to be. With careful planning, the investor can wait to sell certain rising shares until the proper time to realize a profit and effectively pay all taxes. Investors should usually not try to trade shares back and forth that have not been held longer than one year.
Mutual Funds
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Mutual funds give investors ways to buy many different types of stock in one bundle. Some mutual funds are aggressive and can generate high taxes, while others are tax friendly and have relatively low turnover, allowing investors to save more on taxes. Which fund works depends on how the investor wants to plan future investments.
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References
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