There’s no doubt about it: making financially sound investments into profitable stocks can generate a lucrative amount of money. However, when investors begin to swim in their sea of proceeds, they tend to forget about one little friend standing right behind their shoulder: Uncle Sam. Let’s be real, no one wants to pay taxes. Seeing your profits syphoned off is not a pretty sight. But failure to properly file and pay taxes on your investments can lead you into a ton of trouble with the IRS. It might be frustrating, but there are plenty of reasons to file your taxes—you just need to know how.
We’ve gathered the most frequently asked questions about how to file taxes on investments so you can approach the upcoming tax season with wind in your sails (as opposed to drowning in a sea of penalties).
What tax do I have to pay on stocks?
You don’t have to pay taxes on stocks until you actually sell your shares. Once you sell, the amount of tax you’ll owe depends on how long you’ve had the asset, which tax bracket you file in, and whether you lost or gained money.
In the event that you made money on the sale of a stock, you will need to report it to the IRS and pay a capital gains tax on the proceeds. The formula looks like this:
Sales Proceeds – Basis = Taxable Profit or Deductible Loss
Note: Your basis refers to the cost of the stock plus any reinvested dividends. It’s also important to report capital losses, not just gains, since they can be balanced out across all of all of your investments until you reach a single net profit or loss.
Investors who manage a large stock portfolio should think about seeking tax preparation services in order to make sure all capital losses and capital gains are correctly accounted for.
Are cryptocurrencies different?
According to the IRS, any money made from the transaction of exchanging of cryptocurrency is considered taxable by law. They’re treated like capital assets (similar to stocks, bonds, real estate, etc.) and are therefore not taxed like your income. You don’t need to report the purchase of a cryptocurrency to the IRS; filing taxes is only mandatory when losses or gains create a taxable event, just like your stocks.
If you sell your cryptocurrency (or any capital asset) at a loss, you can claim up to $3,000 for single filers or $1,500 for those married and filing separately. This reduces your total income and lowers your overall tax obligation.
Always keep good records when it comes to managing your stocks and cryptocurrency, as the length of time you hold onto a capital asset determines how it is taxed; if you held it for more than a year before a taxable event occurs, it’s considered a “long-term” gain or loss and it’s taxed at a lower rate. Assets held for less than a year are taxed as “short-term”, so whenever you make an investment, remember to record the date, amount you bought it for, when you sold it, and for how much.
What happens if I don’t file?
If you don’t file your taxes by the deadline, the IRS may file a substitute return on your behalf in order to gauge the amount of taxes owed. The government will not apply standard deductions to your return, meaning that your tax liability may be larger than what it would have been otherwise.
You will not receive any money from the substitute return that might have been owed to you. The IRS may also assess a failure-to-file penalty, which is usually five percent of the unpaid taxes for each month or part of a month that the return is late and starts accruing the day after the deadline.
What if I can’t pay?
If you can’t pay your taxes, it’s still in your interest to file a return. The failure-to-pay penalty is substantially smaller (usually one to one-half percent of your unpaid taxes), so filing a return—even if you can’t pay—will save you roughly four percent in fees, plus you will be able to utilize standard deductions to lower your tax liability. You might be able to avoid additional interest and late fees if you pay what you are able to now, and seek out alternative payment methods with the IRS later.
Stocks are a great investment, especially in tax-sheltered retirement accounts, but make sure you’re following the laws on capital gains this tax season in order to keep all those profits.