Updated August 18, 2021

Stock and option trading and taxes can be complex. To complicate matters more, the recent tax reform may impact how your taxes will be assessed. Here are six things that you should know about taxes on stocks and options in 2018.

6 Things Traders Need to Know about Taxes on Stocks and Option Sales:

1. When to Pay Taxes
2. Short-Term vs. Long-Term Capital Gains
3. Taxes on Options
4. Taxes on Stocks
5. Capital Loss Harvesting and Gifts
6. Alternative Minimum Tax (AMT) and Net Investment Income Tax (NIIT)

Trading with stocks and options can be a smart way to invest. It’s important to understand how these types of investments can affect your tax liability.

When to Pay Taxes

Traders investing in stocks and options may have to pay estimated taxes quarterly as well as when exercising or selling those investments. An option is exercised when the holder chooses to take shares of stock from the company at the agreed rate. Depending on the type of option and other factors, you may have to pay taxes on the difference between the exercise or strike price and the fair market value. The time when you must pay and the rate of taxation will also depend on how long you have held the investment.

Generally, you will owe taxes on gains which are due as they apply. The estimated tax from income which is not subject to withholding must be paid quarterly to avoid a tax penalty. In the case of some options, an employer may withhold and report taxes for you, but this is not always done. Due to the complexity of some investment options, you may wish to consult with a tax advisor.

Short-Term vs. Long-Term Capital Gains

An important distinction is made for stocks and options held for longer periods of time. Short-term capital gains for sales made within a year of purchase are usually taxed as regular income. For many investors, this is higher than their long-term capital gains rate. Under Trump’s new tax reform, long-term capital gains can range from 0% to 20% depending on income. Single filers with income under $38,600, joint filers under $77,200, and heads of household under $51,700 may be eligible for 0% tax on long-term capital gains. Those over this may be subject to 15% long-term capital gains up to taxable income of $425,800 for single filers, $479,000 for joint filers, and $452,400 for heads of households. Above this, long-term capital gains are taxed at 20%. Typically, long-term rates are better than short-term rates for promoting long-term investments in the U.S.

Taxes on Options

Options are investment opportunities that offer the right to buy or sell stock at an agreed price up to a specified expiration date. Options are usually limited to employees but can be available to other qualified investors. How options are taxed depends on the type of option, when it is exercised, how long they are held, and the net gains or losses. Some options also limit when you can exercise them. Carefully consider the option agreement before deciding to purchase this investment.

There are two general types of options, incentive stock options or ISOs and non-qualified stock options or NSOs (also NQSO and other variations). ISOs offer several tax benefits including not being subject to regular tax when exercised. However, the spread or difference between the strike price and fair market value may be subject to the alternative minimum tax (AMT). It is also important to note that to benefit from long-term capital gain rates, the stocks must be held for a year from the exercise date as well as two years from the grant date when the option was obtained.

In contrast to an ISO, non-qualified stock options or NSOs do create taxable events when exercised. They create requirements for employers regarding tax withholding and deductions. This gain is taxed as regular income, and if purchased from your employer they should list the gain on your W-2. In some cases, an employer may not do this, in which case you would be required to pay those employment taxes which might include Medicare and other taxes. There are also mitigating circumstances impacting your tax liability in regards to how this initial exercise gain may be taxed. For example, it is important to consider the cost basis of those options as well as if a net loss can be deducted. On top of this initial taxation, you will also face capital gains taxes when the stocks are sold as mentioned below. Because of the complex and varied nature of options, it would be best to consult with a tax advisor about the specifics of your tax situation. There are many strategies available to you depending on your income level and retirement goals.

Taxes on Stocks

There are many different types of stocks available, and each may have different taxation requirements. Stocks can be taxed on capital gains when sold or on dividends received from the company. The profit from the sale of a stock can be determined by subtracting the cost basis from gain. This can include the original cost of the stock plus reinvested dividends and even commissions paid to acquire them. The nature of how the stocks were acquired will also impact taxation. For example, if the stocks were inherited the basis becomes the fair market value which could save you on capital gains taxation. If the stocks were gifted they may either become the fair-market value or the basis of the donor when the gift posted. How long the stocks are held before being sold will also impact taxation as mentioned above. Long-term capital gains are treated more favorably at lower rates. It may be worth your time to wait and sell stocks at a later date in order to reap the tax benefits.

Dividends are taxed differently than capital gains. Some qualified dividends may be taxed at the lower capital gains rates of 0% to 20%. For example, these are offered by certain companies in the U.S. and some qualified foreign corporations, when held for more than 60 days. Since there are exceptions to this, consult with a tax advisor for detailed information on your specific tax situation. Nonqualified dividends are taxed as normal income rates. It is important to note that you may be required to pay taxes throughout the year based on your estimated tax liability from income not subject to withholdings. You may also consider investing stocks in qualified tax-deferred retirement plans.

Capital Loss Harvesting and Gifts

A tax-loss harvesting tactic to consider is selling stocks at a loss to gain a deduction. While the maximum deduction is limited to $3,000 per year or $1,500 for married filing separately, any excess amount over gains can be applied to later years. There are limits to consider with this tool. If you re-invest in the stock that caused the loss within a certain time frame, you may not be eligible to take the deduction.

Another method to reduce the impact of capital gains is to consider gifting. Gifts up to $15,000 a year per individual can help offset your tax bill. In addition to this, you might consider charitable giving or gifting stocks to a charity. While the new standard deduction offered by Trump’s tax reform has decreased the value of itemizing, you may still be able to benefit from this method to offset capital gains. Also, there may be an option to invest these gifts into tax-deferred vehicles for additional savings. As with all of these recommendations, please consult with a tax professional to ensure such a strategy will impact you positively.

Alternative Minimum Tax (AMT) and Net Investment Tax (NIIT)

The Alternative Minimum Tax (AMT) was designed to ensure that those above a certain income threshold would still pay an appropriate amount of tax despite available deductions and exemptions. In order to do this, it calculates tax differently than regular income tax using higher rates of 26% for Alternative Minimum Tax Income (AMTI) up to $95,700 for those married and filing separately and 28% above that, and 26% for other filers up to $191,500 and 28% above that. Under the Tax Cuts and Jobs Act, the impact of AMT was decreased for low to medium income taxpayers in part due to the increased standard deduction and the decrease in value of state and local tax (SALT) deductions to $10,000.

Taxpayers below certain income levels are exempt from the AMT. Under Trump’s tax reform, these values have increased to reflect inflation and take the burden off middle-income taxpayers. The exemptions include up to $70,300 for single or head of household filers, $109,400 for married joint filers, and $54,700 for those married and filing separately. Also, the threshold for eligibility and phase out levels has increased as well. The AMT may be triggered by events such as exercising an ISO which is why you may want to consider this.

Investors may also want to consider the Net Investment Income Tax which may apply in addition to regular income tax and the AMT. For those with investment incomes that exceed a certain threshold, an additional 3.8% tax may apply. This can include income from dividends, capital gains, rentals, and more. These thresholds are $200,000 for single or head of household filers, $250,000 for joint filers, and $125,000 for those married and filing separately.

What You Need to Know About Taxes on Stocks and Options

Stocks and options offer traders a variety of ways to invest. Depending on your personal tax strategy you may wish to diversify and include both types of investments in your portfolio. However, stocks and options can complicate your tax liability. First, when you pay taxes on stocks and options depends on a variety of factors including when you exercise the options to when you sell the stocks. You may also have to pay taxes on dividends throughout the year. Next, the length of time you hold a stock will impact the rate at which an investment is taxed as capital gains or as regular income. Generally, longer investments offer lower tax rates in the U.S.

How an option is taxed depends on the type of option it is and the value when it is exercised. Incentive Stock Options (ISOs) may trigger the Alternative Minimum Tax (AMT) but would not be counted as regular income when exercised, but to get the capital gains tax rate you must hold the stock for more than two years from the grant date. Non-qualified Stock Options (NSOs) do create taxable events when exercised which are taxed as regular income. They also create withholding and deduction issues for employers which may impact you. Beyond that, they are subject to short and long-term periods for capital gains.

There are many types of stocks available as well which are generally taxed on capital gains and dividends. Dividends are usually taxed as regular income but some preferred stock may be eligible for consideration as long-term capital gains. Be sure to consider the basis when considering gains or losses. You may also consider investing stocks into tax-deferred accounts or gifting them to bypass the impact of some capital gains. Visit this link to learn more about tax-free and tax-deferred investments. You may also be able to use capital losses to offset capital gains in what is called loss harvesting.

Next, beware the Alternative Minimum Tax (AMT), especially aimed at those in higher income brackets. This is calculated separately from regular income and is generally subject to higher tax rates. In addition to the AMT, investors must consider the Net Investment Income Tax (NIIT) which adds an additional 3.8% for certain taxpayers.

Because of the complexity and variety of stocks and options as well as strategies available to maximize these offerings, it may be in your best interest to consult with a professional tax advisor about your particular tax situation. Reach out to Anderson Advisors today for more information.