First-Time Investor? Here’s What You Need to Know About Taxes

With the advent of apps and web services geared toward casual, amateur investors—Robinhood, Acorns, and Zacks Trade, for example—the number of people trying their hand at trading stocks is increasing daily. 

This can be a great way to make some money and enjoy yourself while doing it. But if you’re not prepared come tax time, you could find that you owe more money than you bargained for thanks to your trading habit. 

If you’re just getting into investing, here’s what you need to know about taxes. 

Keep records of your transactions

While the app or brokerage you use will maintain reliable records, it’s a good idea to keep your own in case something happens. After all, companies do get cyber hacked, have outages, and sometimes lose data. If that were to happen around tax time, you could end up without the information you need to file properly. 

The things you should track include: 

• What stocks you’ve purchased
• Number of shares
• What you’ve sold
• Dates of all transactions
• Cost basis 
• The sale price of the stock sold
• Commissions or other fees paid
• Withdrawals from your account

How are your investments taxed?

Perhaps the most important thing every investor should understand is how those investments are taxed. 

Investments are only taxed if you sell shares and realize it as a gain. So, if you own one share of a $100 stock, and you sell it at $200, you would owe capital gains taxes on the $100 profit that you made by selling. 

But how do you know what tax rate you pay on those profits? 

First of all, there are two types of capital gains taxes: short-term and long-term. 

Short-term capital gains apply to profits you make from the sale of investments (or any asset) that you bought and sold within a single year (in other words, you’ve “held” the stock for one year or less). 

Long-term capital gains tax applies to profits you make from the sale of investments (or any asset) you’ve held for more than one year. 

The short-term capital gains tax rate is the same as your income tax bracket—so, if you’re taxed at 22% regularly, that’s your short-term capital gains tax rate, too. 

For long-term capital gains, the tax rates for 2021  if your filing status is single are: 

• 0% of your income is $0-$40,400

• 15% of your income is $40,401-$445,850

• 20% of your income is $445,851 or more

Offsetting gains with losses

Of course with any stocks, you could sustain more losses than you realized gains in a given year. If so, that loss can be used to offset your income, up to a certain amount. 

Currently, up to $3,000 in losses can be deducted from your total income, which will reduce your taxable income.

If you lose more than $3,000, any amount over that initial $3,000 can be carried over to future tax years to offset your taxable income. 

Additional tax for investors: the net investment tax

There’s one more tax that investors should be aware of, and that’s the net investment tax. It’s a tax of 3.8% on your net investment income 

This tax doesn’t apply to everyone—only to those who are: 

• Filing single or head of household, and make more than $200,000
• Married filing jointly and make more than $250,000
• Married filing separately and make more than $125,000

The tax of 3.8% applies to your gross income above those threshold amounts, based on your filing status. If you make it under that threshold amount, you won’t pay the net investment tax. 

Tax for dividends

Dividends, or company earnings that are distributed to shareholders, are also taxed. Dividends are divided into two groups for tax purposes: 

Ordinary dividends: taxed like regular income

Qualified dividends: taxed at the long-term capital gains tax rate

How do you know if something is a qualified dividend or an ordinary dividend? 

For qualified dividends, these criteria must be met: 

• The dividend must be paid by a U.S. corporation or qualified foreign corporation (typically, this means the stock is traded on U.S. stock exchanges).
• During the 121-day period starting 60 days before the stock's ex-dividend date (the first trading day on which a dividend payment is not included in a stock's purchase price) and ending 60 days afterward, you must have owned the stock for at least 61 days.

One note: dividends that are paid by pass-through entities, like real estate investment trusts (REITs) are usually classified as ordinary dividends. 

Investing can be an excellent way to increase your wealth and diversify your income over time—as long as you’re prepared to pay accurate taxes on any gains.