Taxes on Stocks: Guide to Paying Less in 2022

Understanding investment taxes can take a bit of work, but many investors find the effort is well worth it. With practice, strategic investing might help you lower your tax bill while you grow your portfolio. Learn the ins and outs with this guide to capital gains, dividend earnings, stock options, and more.

Note: Stash can’t give you advice about your specific financial situation, and this article is for general education only. For personalized advice and any additional questions, consider working with a tax professional.

How do taxes on stocks work?

As a general rule, the money you earn from stocks and other investments is taxable. The tax rate on stock gains depends on the type of earnings, such as:

• Profit from selling shares of stock
• Dividends you receive
• Interest you earn on money in brokerage accounts

There is an exception: Earnings in tax-advantaged accounts for retirement may be tax-deferred or tax-exempt. For example, 401(k), 403(b), and traditional IRA earnings are generally not taxable until you make withdrawals. And if you have a Roth IRA, earnings and qualified withdrawals are typically tax-exempt. However, if you make non-qualified withdrawals, like taking money out before age 59½, you’ll generally pay taxes plus a penalty.

Capital gains tax

Most of the money you earn from your stock investments is considered capital gains. The tax rate on stock gains may be lower than the rate on your regular income, so understanding the intricacies can pay off.

What’s a capital gain?

Capital gains are profits from selling investments. Here’s an imaginary example:

• You purchase 10 shares of stock for $10 each: a total investment of $100. 

($10 x 10 = $100)

• Five years later, the stock price is $15; now your investment is worth $150. 

($15 x 10 = $150)

• You sell the stock, making $50: $150 minus your $100 initial investment.

($150 – $100 = $50)

• The $50 profit is “realized” when you sell the stock; that’s the capital gain. There’s no capital gain until you sell the stock, no matter how much the price rises.

What’s a capital loss?

If you sell an investment for less than what you paid for it, that’s called a capital loss. It’s calculated just like a capital gain: Subtract your initial investment from the total sale price. In some cases, you can carry over capital losses from prior years.

What are short-term and long-term capital gains?

If you hold a stock for less than a year before selling, the IRS considers the profit you earn a short-term capital gain. But if you hold it for more than a year, the earnings are long-term capital gains. You’ll need to understand both, because capital gains tax rates are generally different for each.

Short-term capital gains tax

Short-term capital gains are taxed as ordinary income, just like the income you earn from your job. As of 2022, those rates ranged from 10% to 37%, depending on your tax bracket.

Long-term capital gains tax

Long-term capital gains are usually taxed at a special capital gains tax rate: 0%, 15%, or 20%, based on your income. In rare cases, the rate goes as high as 28%. But for many people, it’s less than their normal income tax rate.

What’s a net capital gain?

According to the IRS, “the term ‘net capital gain’ means the amount by which your net long-term capital gain for the year is more than your net short-term capital loss for the year.” So if you have long-term capital gains but short-term capital losses, subtract the losses from the gains to arrive at your net capital gain. This is the amount of money on which you’ll owe taxes.

Dividend taxes

Dividend income is typically taxable; the rate depends on what type of dividends you earn:

• Ordinary dividends are taxed at your ordinary income tax rate.
• Qualified dividends are taxed as capital gains. 

Whether your dividends are ordinary or qualified largely depends on whether you have met the holding period, which means you held the stock for 60 to 90 days during a given window of time. Your 1099-DIV tax form will tell you which category your dividends fall into.

Taxes on stock options

You might receive stock options as part of your job’s compensation package; this is most common in startups and tech companies. A stock option gives you the right to buy a stock at a particular price, called the grant price, regardless of the stock’s market price at the time you buy it. When you decide to buy stocks at the grant price, it’s called exercising your stock option. Ideally, the price of the stock is higher than the grant price when you exercise your option, so you get a bargain. 

Here’s a hypothetical example of how it might work:

• Your company gives you stock options with a grant price of $20 per share, and you’re allowed to buy 100 shares at that price.
• When you exercise your stock options, the stock is valued at $30 per share, and you buy 100 shares.
• You spend $2,000 ($20 x 100), and the shares you now own are worth $3,000 ($30 x 100).
• You can now hold onto those shares or sell them.

Taxes on statutory vs. nonstatutory stock options

Stock options are considered either statutory or nonstatutory, and taxes work differently for each type.

• Statutory stock options: You usually don’t incur any taxes when you exercise your options, though you may be subject to alternative minimum tax when you file your tax return. When you sell the stocks, any income you make will generally be subject to taxes. The rate at which your profit is taxed depends on a few factors, including whether your options are qualified or non-qualified and how long you have held the stock. Your capital gains will be classified as short- or long-term based on how long you’ve held the stock.

• Nontatutory stock options: If the common price of the stock is higher than the grant price when you exercise your option, like in the example above, the difference between what you paid and what the shares are worth is usually considered taxable by the IRS. You’ll also be subject to short- or long-term capital gains taxes when you sell your stocks.

When do you pay taxes on stocks?

Taxes on investment income are usually due on the same schedule as other taxes. For most people, that’s when you file your annual tax return, but some people pay quarterly estimated tax or use another fiscal calendar. 
One exception is if you hold stock in a tax-advantaged account, like a 401(k), 403(b), or IRA. In that case, you probably won’t owe taxes unless you’ve made a qualified withdrawal; if you have a Roth IRA, qualified withdrawals aren’t usually taxed at all. Non-qualified withdrawals, however, may trigger tax liability plus a penalty.

How to pay lower taxes on stocks

Here are five strategies that might make an impact on your tax bill:

• Buy and hold. Holding onto your investments for a year or more may help you secure the lower long-term capital gains tax rate for dividends and money you make selling stock.
  
• Open a traditional or Roth IRA. These accounts offer multiple tax advantages that might add up to significant tax savings over the long term.
  
• Contribute to your 401(k) or 403(b) plan. With pre-tax contributions and deferred taxes on earnings, your contributions could reduce your taxes today and tomorrow.
  
• Hold dividend-paying stocks in tax-advantaged accounts. Any tax-advantaged retirement account might reduce your tax liability. For instance, dividends earned on stocks in a 401(k) or individual retirement account aren’t taxed until you make qualified withdrawals. And in most cases, dividends earned in a Roth IRA are not taxable, provided you follow withdrawal rules.

• Use short-term capital losses to offset long-term capital gains. By investing strategically, you may be able to balance out losses and gains to reduce the amount of taxable income you receive from selling stocks.

Tax updates for 2022

The IRS implemented some tax changes for 2022; here are a few highlights you may wish to be aware of:

• Income tax brackets were adjusted, so you may be in a lower tax bracket than last year if your income hasn’t changed.
  
• Long-term capital gains tax brackets have also been adjusted upwards.

• Contribution limits for IRAs and 401(k)s have increased.

Understand the tax implications when you invest

If you earn money through your investments, it will likely affect your taxes. There are a number of strategies you can employ to possibly reduce the taxes on stocks. You may wish to work with a tax professional to understand how various approaches work for your personal circumstances. And Stash’s Tax Resource Center can help you stay on top of important tax dates and forms.

Stock taxes FAQ

Can you claim losses on taxes?

Sometimes. There are limits on how much “excess loss” you can deduct through tax-loss harvesting, and capital gains could offset capital losses. You may be able to carry excess loss forward to future tax years.

How do you avoid capital gains tax on stocks?

Trading stock within tax-advantaged accounts for retirement, like IRAs and 401(k)s, typically does not trigger the capital gains tax, although qualified withdrawals are taxable. 

If I reinvest my dividends in a DRIP program, do I have to pay taxes?

Participating in a Dividend Reinvestment Programs (DRIP) doesn’t directly affect your tax liability. But DRIP programs usually boost the power of compounding, which gives you the potential for greater returns over the long term.

Do I have to pay taxes if I don’t sell my stocks?

Generally, no. Except in special circumstances, you only pay taxes on money you earn when you sell your stocks. If you hold onto stocks that increase in value, there are no tax implications.