Entering into the Stock Exchange

There are three types of taxes that are paid on stocks in non-retirement accounts. Individual Retirement Accounts and Pension Plans are not taxed until withdrawn and then the money taxed is taxed as ordinary income, except for Roth IRAs where the earnings are never taxed.

Dividends are taxed each year at the same rate as your income. Those federal tax rates can be 15%, 28%, 31%, etc., plus any applicable state and local income taxes.

The other type of tax on stock is capital gains/loss tax. This tax is incurred when you sell a stock. Let’s say you purchased a stock at $10 a share and sold it 6 months later at $15 a share. You have a profit of $5 a share and because you held the stock for less than 1 year, you have a short-term capital gain that is taxed as regular income. If you held this stock for 12 months or 3 years, you have long-term capital gain which is taxed at a lower rate.

For those taxpayers in the 15% income tax bracket, they would be taxed at 10% long-term capital gains rate and all other taxpayers are taxed at the 20% tax rate. Starting in 2001, for investments held 5 years or longer, these rates are 8% and 18%, respectively. For individuals taxed at the higher income tax rate, 20% is much better than 28% or higher, so this encourages investors to hold stock long term. In a situation where you lose money on a stock that you sell, those losses are subtracted from the capital gains you made. If you had no other gains that year, up to $3000 of net capital loss a year can be deducted against other income. See your tax advisor for the details of capital gains/losses.

Extract from “Ohio State University FactSheet”