Will Rogers once said, “Baseball is America’s game–it, and high taxes.” That certainly underscores how much taxes go hand-in-hand with the American way of living. However, the more you know about what creates a tax liability, the better you can prepare for and attempt to minimize taxes.
A dividend is the interest your stock earns when the company makes a profit. Periodically a stock will distribute dividends to its shareholders. Regardless of whether you receive a cash dividend or have it automatically invested back into the stock, the distribution is subject to your ordinary income tax rate at the federal level.
Short-Term Capital Gains
A short-term capital gain is the profit distributed when you sell shares you’ve only owned for one year or less. Short-term gains are subject to ordinary income tax rates.
Long-Term Capital Gains
A long-term capital gain is the profit distributed when you sell shares you’ve owned for more than one year. Capital gains may be taxed at 5, 15, 25 or 28 percent or a combination of rates, depending on your ordinary income tax rates and other factors. Visit www.irs.gov for details. These tax levels are known as long-term capital gains and apply to assets that you hold for at least 366 days (more than one year). The long-term capital gain tax generally is much lower than what you pay on your regular income.
Calculating Gains & Losses
When you sell shares, you generally incur either a gain or loss. If your selling price is less than what you originally paid, you incur a loss. Losses may be used as a deduction against gains when filing your tax return.
Gains, on the other hand, occur when you sell shares for more than you originally paid. Gains are subject to capital gains taxes.
To calculate your capital gains or losses, you must determine the cost basis of the shares you own. The cost basis is the original purchase price of the stock, and you determine your tax liability through one of the three following calculation methods:
- Average cost method
- Specific identification method
- First in, First Out (FIFO) method
Check with your financial advisor or accountant for the specifics of each method.