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. The taxation of capital gain from the sale of shares depends on how long the asset is held, and additional rules apply to shares acquired from incentive stock options (ISOs). Capital gains and losses may be short-term or long-term:
- short-term capital gains or losses: securities held for one year or less
- long-term capital gains or losses: securities held for more than one year
To calculate the holding period, start with the day after your acquisition date and count through the date when you sell the shares.
Tax Rates On Long-Term Capital Gains
Short-term capital gains are taxed at ordinary income rates. Long-term capital gains have their own tax rates:
- The top rate of tax on long-term capital gain is 20% (under the American Taxpayer Relief Act). In 2017, this highest rate applies to single filers with yearly taxable income of more than $418,400 and to married joint filers with yearly taxable income of more than $470,700. (In 2016, these thresholds were $415,050 and $466,950.)
- For most people with less yearly taxable income, the capital gains rate is 15%.
- For taxpayers in the 10% or 15% income tax bracket, the capital gains rate is 0% (unless the kiddie tax applies).
- For people with annual modified adjusted gross income of more than $200,000 (more than $250,000 for married joint filers), a Medicare surtax of 3.8% applies to investment income, including capital gains. This essentially raises the top rate on capital gains to 23.8%. 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.
Alert: In May 2017 the House of Representatives passed the American Health Care Act (AHCA), which is intended to replace and repeal the Affordable Care Act (Obamacare). For details on the bill, see a special report from CCH. Section 251 of the AHCA would eliminate the Net Investment Income Tax (i.e. the 3.8% Medicare surtax on investment income). To be enacted, the legislation must still be adopted by the Senate, where changes are expected.
Summary Of Capital Gains Rates And Thresholds In 2017
||0% tax rate on capital gains
||15% tax rate on capital gains
||20% tax rate on capital gains
||3.8% Medicare surtax on capital gains
||Not over $37,950
||Over $37,950 but not over $418,400
||Not over $75,900
||Over $75,900 but not over $470,700
More Tax Rules
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.
Alert: To accurately calculate and report a gain or loss on your stock sale, you must know your cost basis.
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.