What is the tax rate when selling a stock or mutual fund?
From FinancialPlanning
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Quick Answer
Stocks and mutual funds are considered capital assets under the Internal Revenue Code. Capital assets can be taxed at special capital gains rates rather than the bracketed rates that apply to ordinary income. The rates that apply depend on how long you've held the stock or fund.
The maximum tax rate on long-term gains is 15% (5% if your taxable income falls within the lower tax brackets). Short-term gains are taxed the same as ordinary income.
State Income Taxes
You'll also pay state income taxes on capital gains, and many states don't have a special tax rate for them.
Details
Long-term vs. Short-term
The tax rate for capital gains depends on your holding period -- how much time has passed since you bought the investment. Long-term assets are those you have held for one year or more, and short-term assets are those held less than that.
Special rule for inherited assets
If you inherited a stock or mutual fund, your gains or losses are "long-term", regardless of how long you actually held the investment.
Gains or Losses
The difference between sales price and basis equals your gain or loss. When calculating this you look at "net" figures...deduct any commissions paid from your sales proceeds, and include commissions in your purchase price.
Ordering Rules
If you acquired the stock or mutual fund shares at different times and prices, and only sell some of them, the question arises of which shares you sold. This can have a big effect on your taxable gains...for example imagine you bought two batches of 100 shares of a stock, one for $50/share and the other for $30/share. If you sell 100 at $45/share you either have a $15/share gain or a $5/share loss.
The default order, per the IRS, is "FIFO" meaning "first in, first out." This is the method you're required to use if you can't prove another method.
You can instead "specifically identify" the shares you want sold. You do this by notifying your broker, and having them send a written confirmation of the request (for example: sell 100 shares vs. my purchase January 4, 2001). Some brokers and fund companies are better than others at fulfilling this request, but it's technically required by the IRS.
Mutual funds have several lot-accounting methods available, and allow use of "average cost" when calculating gains. They also have some quirky rules for hares sold shortly after purchase. A full discussion of the topic is beyond the scope of this article. See the IRS publication on mutual funds for details.
"Netting" on Schedule D
Schedule D is the attachment to your federal income tax return that addresses capital gains and losses. On Schedule D you group all of your sale transactions by term: short-term holdings, and long-term holdings. You net out the gains or losses within each category, then add the two to determine your net capital gains or losses for the year.
How the gains or losses are taxed depends on your bottom line on Schedule D, and on how the gain or loss divides between long- and short-term. Generally speaking any short-term gains are taxed the same as ordinary income, unless there are adequate long-term losses to cancel them out. Long-term gains are taxed at a maximum 15% rate, which is set to just 5% for taxpayers whose total income falls within the 15% or lower federal income tax brackets (in 2006 that meant $61,300 in taxable income for a married couple filing jointly).
Net Losses
If your Schedule D adds up to a net loss, you won't pay tax on whatever sales that year resulted in gains. You can use up to $3,000 of that net capital loss as a deduction against other income -- salary, interest, dividends, etc. If your loss is greater than $3,000, you carry-forward the excess to next year's tax return, where it's included again in the calculation of net gains/losses (broken down in the appropriate section long/short term).
Special Cases
Wash Sales
Tax rates are effectively different if you have a wash sale, because losses won't be immediately deductible.
AGI effects
Capital gains are included in your AGI (adjusted gross income -- the last line of page one of your federal income tax return). Many tax benefits and deductions are keyed to your AGI, so capital gains can have an effect on them. For example, itemized deductions and personal exemptions are phased out (i.e., partially unusable) at higher AGIs. Miscellaneous itemized deductions and medical-expense deductions are limited based on AGI. The ability to contribute to a Roth IRA is tied to AGI. Student loan interest is deductible only if AGI is below a certain level. There are other examples -- point being, while the tax rate on capital gains is technically just 15%, the existence of a $20,000 capital gain may have the effect of triggering something else on your tax return, resulting in additional taxes paid. So really, the tax rate on that gain is greater than the 15% "maximum."
AMT
The 15% capital gains rate applies as well under AMT, so capital gains are not subject to AMT rates. But the existence of capital gains can throw some of your other income into AMT. So in effect, the capital gain is taxed at a higher rate than 15%, in the sense that some taxes are triggered (they just happen to be calculated with respect to other income).
