Do I Have to Pay Taxes on My Stock Portfolio?

Written by James Hirby and Fact Checked by The Law Dictionary Staff  

As a stock investor, you stand to benefit from several distinct streams of income. First, there's the regular "capital gains" income that you'll realize upon selling stocks that have appreciated in value during the time in which you held them. You can think of this as the "profit" that you stand to earn from your stock holdings. You'll also probably earn regular dividend income thanks to the quarterly or semi-annual cash payments that many public companies make to their shareholders. You may also earn additional income from a range of "special" situations, including special dividends, buyouts and stock splits. Since the earnings that you'll realize from these special events can be difficult to calculate, you'll need to study the companies that you own to ensure that you're getting a fair deal.

If you own your stocks in a traditional brokerage account that isn't tax-deferred, the tax implications of your stock holdings can be difficult to grasp. The U.S. Tax Code taxes regular and special dividend payments as "regular" income. The marginal tax rates that you pay on these earnings will be identical to those that you pay on your salary and wage earnings. Capital gains are a bit more complicated: "Long-term" gains may be taxed at lower rates than "short-term" gains. To qualify for "long-term" capital gains, you'll need to hold a particular stock for at least one calendar year.

If a portion of your stock portfolio is protected by a tax-deferred retirement account like an IRA or 401(k), your tax calculations are likely to be far different than those of the traditional investor. In most cases, all of the dividends and capital gains that you earn on the stocks in your tax-deferred account will be exempt from taxation. Instead, you'll pay taxes on either the funds that you initially invest into the account or the funds that you ultimately withdraw from the account. In either case, you'll be off the hook for thousands of dollars in tax payments.

Unfortunately, tax-deferred retirement accounts have fairly strict eligibility limits. For instance, both traditional and Roth IRAs have contribution limits of $5,000 per year. In other words, you can can only shield principal balances of up to $5,000 per year from taxation using these accounts. After you turn 50, you may be able to contribute up to $6,000 per year into these accounts. There are similar limits for Health Savings Accounts, 529 Plans and other tax-deferred savings vehicles.

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