|What are capital gains and capital losses? What are the capital gains tax rates?|
Capital gain is income that arises from the sale of a capital asset. Gain from the sale of securities held for investment, such as shares acquired from stock compensation, is a type of capital gain. Long-term capital gains have their own tax rates. Short-term capital gain is taxed at ordinary income rates.
Tax Rates On Long-Term Capital Gains
The taxation of long-term capital gains changed at the start of 2013. For stock sales that were made before the end of 2012, the rate on long-term capital gain was 15% (but 0% for taxpayers in the 10% and 15% income tax brackets). With effect from January 1, 2013:
Alert: Because of the income thresholds outlined above, income from stock compensation can increase not only your income tax rate but also your capital gains rate, and it can trigger the Medicare surtax on investment income.
The taxation of capital gain from the sale of stock depends on how long the asset is held, and additional rules apply to incentive stock options (ISOs). Capital gains may be short-term (from securities held 12 months or less) or long-term (from securities held more than 12 months). To calculate the holding period, start with the day after your acquisition date and stop counting on the day when you sell the shares.
Capital losses are used to offset capital gains to establish a net position for tax purposes. Only $3,000 of net capital losses can be deducted in any one year against ordinary income, and the remaining balance is carried over to future years indefinitely. For additional details on the tax rules, and for annotated examples of tax return reporting for company stock sales, visit the Tax Center. See also the FAQs on gifting and donating stock for related planning ideas involving capital gains.
You must file Form 8949 and Schedule D with your federal Form 1040 tax return for any tax year in which you have sold stock. You must file these regardless of whether you have a gain and even if you sold option stock immediately at exercise (i.e. cashless exercise, same-day sale) or if you sold restricted stock at vesting. On your tax return, you report the exercise date (vesting date for restricted stock) as your purchase date, even though your holding period does not begin until the following day. For details, see the section Reporting Company Stock Sales in this website's Tax Center.
State Capital Gains Tax
Most states tax capital gains at the same rate as ordinary income, which is good news in states without individual income tax. However, as pointed out by an article in InvestmentNews, this is "terrible news" for people who sell stock in states such as California (13.8% rate) and New York (8.8%). Some states, such as New Jersey, also do not allow capital-loss carry-forwards, making the timing of gains and losses in the same year more important than usual.
As articles and FAQs in the ISO section and the Tax Center explain in detail, with plenty of examples, the calculation of capital gains for ISOs is more complex than it is for NQSOs. For instance, if you exercise ISOs and sell the stock within one year after exercise (i.e. disqualifying disposition) when the market price is lower than it was at exercise (but still above the exercise price), your full gain is ordinary income. In addition, if you pay alternative minimum tax (AMT) on the exercise of ISO stock that you hold, your capital gains calculation when you sell will differ for AMT and ordinary income tax.