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When Trading, Don't Forget Taxes


It can seem exciting to make money in the stock market. But when you do well, the government wants a piece of the action in the form of taxes. Each trade can generate either a taxable gain or a loss that can offset a taxable gain. So you may want to maximize after-tax profits by timing when you sell winners and losers or by selling one lot of shares instead of another.

First, know the tax rates. The best rates apply to long-term capital gains — that is, gains on investments held longer than a year. Most investors pay 15%, but the wealthy pay 20%, and those with a low income pay no long-term cap taxes. (The thresholds, adjusted annually, are available on the IRS site.) But if you are a frequent trader, your net profits are typically short-term capital gains, and these are taxed at the same rates as ordinary income, which almost always will be higher than your long-term rates. Either way, taxes eat into profits very quickly.

Learn how to find the silver lining of losses. If losses exceed gains, there's no cap gains tax, and up to $3,000 of losses can be deducted against ordinary income like wages. If you have losses beyond that, they can be carried forward to offset future taxable gains until they're used up.

If you buy shares of the same company at different times at different prices, it can get complicated — but you can use that to your advantage. The Wall Street Journal provides the following example: You buy some shares of Acme Corp. at $5 and on another day you buy more shares at $7. Later, you sell a few shares for $9. Selling $7 shares yields a taxable gain of $2, but selling $5 shares yields a $4 taxable gain — meaning a higher tax bill. If you don't specify which lot, the default is typically first-in, first-out, which often raises your tax bill. So make your wishes clear.

Watch out for "wash sales." This is when you sell a security at a loss but 30 days before or after you buy the same or a very similar one. In such a situation, you do not get to claim the loss.

Are you thinking about trading full time? Some day traders claim their trading is a bona fide business and deduct expenses — for specialized terminals, a home office or tax prep on Schedule C. But this isn't a slam dunk. The IRS has stiff requirements to take this tax haven — you'd need to trade for at least four hours a day for an average of four days a week and make at least 720 trades a year.

Finally, you may hit the annual income ceiling for a 3.8% surtax on net investment income: $200,000 for a single filer and $250,000 for married joint filers. And there are state taxes to consider too: California has a top income tax rate of 13.3% and no reduced rate for capital gains.

The bottom line? Keep taxes in mind as you make trades because there will be a reckoning. Whether you work with a financial planner or take care of your own investments, keep in close touch with a tax professional.


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Our firm provides the information in this e-newsletter for general guidance only, and does not constitute the provision of legal advice, tax advice, accounting services, investment advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal, or other competent advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation. Tax articles in this e-newsletter are not intended to be used, and cannot be used by any taxpayer, for the purpose of avoiding accuracy-related penalties that may be imposed on the taxpayer. The information is provided "as is," with no assurance or guarantee of completeness, accuracy, or timeliness of the information, and without warranty of any kind, express or implied, including but not limited to warranties of performance, merchantability, and fitness for a particular purpose.
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