No, you will not have to pay taxes unless you sell shares at a capital gain. This is the simple answer to the question if you have to pay taxes on stocks you don’t sell.
As a stock investor in the market, taxes are always one of those topics that hover over your head. On the one hand, seeing your investments go up is a really rewarding feeling. On the other hand, you know that you will have to pay taxes on your capital assets eventually.
There is much more to learn about stocks and your tax liability. Read on if you want more details, and be prepared come tax season. Almost all topics I discuss in this post also apply to Mutual Funds and Exchange-Traded Funds (ETFs).
If your investment strategy centers around stock picking for the long term, you will find great value in my investment framework: 20 Questions You Should Ask Before Investing In Stock.
Related Post: Income vs. Value vs. Growth Stocks, which is better?
The Difference Of Unrealized And Realized Gains
When you own a stock that goes up relative to the price you paid, your gain is always called unrealized gain. This is because they aren’t “real” yet. Theoretically, the market could crash tomorrow and take away all your gains.
You realize the gain only when you sell the stock and convert your gains to actual money. At this point, no market movements can take away your gain anymore. Now, you can call your gain a “realized gain.”
You can easily calculate the capital gain of your stock investment by subtracting the sale price from your purchase price. Your purchase price is also called your cost basis. It is the average price you initially paid for the stocks you want to sell.
Do You Pay Taxes On Stock Dividends?
Perhaps the only exception to that rule is dividend income. With dividends, you get a capital gain subject to federal and possibly state taxes. You will have to pay these taxes without selling the stock that earned you the dividend.
Related Post: 5 Reasons Why We Love Dividend Stocks for Long-Term Investment
You don’t pay the same taxes on all your dividends. You need to know the type of dividend you are getting for tax purposes. There are 2 different types of dividends: Qualified Dividends and Nonqualified Dividends.
- Qualified Dividends: You pay capital gains taxes on dividends designated as qualified (0%/15%/20%). There are holding restrictions in place for dividends to qualify. You must hold the stock or ETF for at least 60 days during the 121-day period that begins 60 days before the ex-dividend date. Actively trading an ETF or stock will very likely disqualify your dividend earnings.
- Nonqualified Dividends: Any dividend not designated as qualified falls into this category. You will have to pay taxes at the ordinary income tax rate. This rate is usually higher and depends on your total taxable income.
How Tax-Advantaged Accounts Can Help You Save Taxes
A tax-advantaged investment account either offers a deferral of taxes or is entirely tax-exempt. Examples are 401k plans or IRA plans, including Roth IRA plans. A normal taxable brokerage account can’t give you these benefits.
If you have a 401k plan, you will contribute pre-tax dollars to your account. Even if you are getting dividend payments from your investments, you will not pay taxes immediately on them. The saved taxes will be able to grow with your investments. You must pay taxes based on your capital gains when you withdraw money.
For tax-exempt accounts like Roth IRA, the situation is even better. All your capital gains are completely tax-free. This is why investing in a Roth IRA is a good idea. Keep in mind that there are restrictions and limitations in place.
When You Sell, How Can You Safe On Taxes?
Eventually, you might decide to sell some of your stocks. If your stock sales are realizing a profit, there are a few things to remember. Ideally, you should know the tax consequences before you sell any stock.
Related Post: Explained: How Can You End Up Owing Money On Stocks
6 Tips To Help You Save Taxes On Stock Sales
- Hold for 1+ years – This ensures you pay the lower long-term capital gains tax rate instead of the higher short-term capital gains tax rate. A lower rate can have a big impact on your tax bill.
- Think about why you are selling – Have a real reason why you think selling your stock is the right move. Take a look at my guide, “Knowing When to Sell Your Stock: 9 Rules for Savvy Investors.”
- Spread sale over multiple years – Only sell stocks that will not cause you to move to the next higher tax bracket. Spread out your sales over multiple subsequent years.
- Offset gains with losses – You can sell other stocks at a loss and use that to offset your capital gains. Remember the Wash Sale Rule if you plan to buy back the shares at any time.
- Invest in Tax-Advantaged Accounts – Tax-Advantaged accounts can save you a lot of taxes and are generally a valuable addition to your overall financial plan. Many options are available, like 401k, Roth 401k, IRA, Roth IRA, etc.
- Talk to a Fee-Only Financial Advisor – A financial advisor can help you on your financial journey. You can get valuable feedback and guidance. Finding a good financial advisor is not easy. I recommend the Garrett Planning Network, the National Association of Personal Financial Advisors (NAPFA), and the XY Planning Network. These networks can get you in contact with a fee-only advisor. No matter how much money we are talking about, it will not change your costs.
As you can see, you can save taxes in many ways. These tips will make you a better investor who makes smart investment decisions in the stock market.
Take a look at my more detailed article about exactly that topic:
How To Avoid Paying Capital Gains Taxes On Stocks
Final Thoughts – Do You Have To Pay Taxes On Stocks You Don’t Sell?
It is good to know that you generally don’t have to pay taxes on stocks you don’t sell. By looking at the details, we uncovered some possible taxes you might have to pay on your next tax return.
In this blog post, we dug deeper into this topic, including the differences between taxable accounts vs. tax-advantaged accounts, dividends, realized vs. unrealized gains, and strategies to apply when selling stocks.
There are many details of how taxes come into play when investing in the open market. New investors, especially, might get confused about all the financial lingo you must deal with when dealing with stock gains. Our tax laws are surely not the easiest.
Knowing about them and taking advantage of all available tax benefits makes you a better investor managing your money. The most impactful way to avoid unnecessary taxes is to take advantage of the long-term capital gains rate. There are many different types of investors. By simply engaging in a more long-term approach to investing, you can tilt the odds for success in your favor.
Disclaimer: The information in this blog post should not be considered tax advice or a replacement. They are solely provided for informational purposes. Please consult with a tax professional and tax expert for any specific questions on your taxes. Also, none of the mentioned stocks are to be understood as recommendations. Don’t buy yourself something solely based on what you read here.
