With a nonstop barrage of commercials for online do-it-yourself tax preparation products, you can’t miss it — today is Tax Day! Tax Day can be stressful for anyone, but if you’ve sold some of your investments in the past year, you might be even more on edge. What percentage of the profits you’ve just made are about to disappear in taxes?
To help you out, we’ve put together a list of four of the most common investment-related terms you may have come across when filing your tax returns this year.
1 - Capital Gains Tax
First, let’s define capital gains. Capital gains refer to profit you’ve made from selling an investment. To calculate your capital gains, take the amount of money you sold your investment for, minus the amount of money you spent to buy it. What’s left is your capital gains. For example, if you bought a portfolio for a total of $4000, and then sold them for $5000, your capital gains will be $1000.
Capital gains tax is the specific tax charged on these capital gains.
2 - Short Term Capital Gains
Short term capital gains are profits you make after selling an investment you owned for less than a year. The IRS looks at this money the same way it looks at any other side income. That means that profits from short term capital gains are taxed at the same rate as your regular income tax. Unlike long term capital gains (as we’ll see below) there are no special tax breaks for the money you make from short term investments. In the end, you’ll usually end up paying between 10% and 37% in taxes, depending on your general income tax bracket.
3 - Long Term Capital Gains
Long term capital gains are the profits you make from selling an investment you owned for more than a year. When you choose to invest money in a stock portfolio, it’s typically not a get-rich-quick scheme. You took the time to research your options, you built carefully optimized stock portfolios, and you’re looking to make smart long term financial decisions. Ideally, you won’t cash out your stocks until you’re sure it’s the most advantageous time to sell.
The IRS and the US government encourage this type of financial responsibility by giving better tax rates on long term capital gains. Long term capital gains tax rates can be as low as 0%, or up to 20%. So if you’ve held on to an investment for a good while and you are sure that now is the time to sell, go ahead and do it. You won’t regret it.
4 - Offsetting Your Gains
Say you’ve built a stock portfolio that has a few underperforming investments. Maybe that risk you took on an auto company that manufactures three-wheeled cars is not exactly panning out. You find yourself taking considerable losses. Selling those stocks before the end of the tax year is a smart plan. The money you lost in the investment is called negative income, and that can be subtracted from your total capital gains. This process is called offsetting your gains. When you succeed at using any negative income to offset your gains, you walk away with more money in your pocket at the end of the year.
Time To Get Filing
As you can see, the concepts are pretty simple even if the paperwork isn’t. Now that you have a basic understanding of the terms, you are ready to file your taxes without worrying about how much of your hard earned money will go to Uncle Sam. You might even find yourself enjoying those tax software commercials.