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 Capital Gains

Short-term capital gains are taxed at ordinary income rates. Therefore, when your marginal tax rate changes, as it probably did starting in 2018, under the Tax Cuts & Jobs Act, your short-term capital gains rate also shifts. Lower marginal tax rates mean a cut in the tax rate on short-term capital gains.

Long-term capital gains have their own tax rates:

  • For most people, the tax rate on long-term capital gains is 15%.
  • For people with very high incomes, the rate is 20%. For 2017, the 20% capital gains rate was tied to the highest income tax bracket and therefore applied 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 2018, under the Tax Cuts & Jobs Act (TCJA), the threshold is $425,800 for single taxpayers and $479,000 for married joint filers. Those thresholds are no longer tied to the highest income tax bracket.
  • For people with low incomes, the capital gains rate is 0% (unless the kiddie tax applies). For 2017, the 0% rate applies to taxpayers with income in the 10% or 15% income tax bracket. In 2018, the 0% rate applies to taxpayers with income in the range of the 10% or 12% income tax bracket (the TCJA lowered the 15% bracket rate to 12%).

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.

Summary Of Capital Gains Rates And Thresholds In 2017

Filer status 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
Single Not over $37,950 Over $37,950 but not over $418,400 Over $418,400 Over $200,000
Joint Not over $75,900 Over $75,900 but not over $470,700 Over $470,700 Over $250,000

While the Tax Cuts & Jobs Act did not change the core capital gains tax rules, and the brackets remain indexed for inflation, the rates are no longer perfectly matched with the thresholds for the income tax brackets.

Summary Of Capital Gains Rates And Thresholds In 2018

Filer status 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
Single Not over $38,600 Over $38,600 but not over $425,800 Over $425,800 Over $200,000
Joint Not over $77,200 Over $77,200 but not over $479,000 Over $479,000 Over $250,000

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.

Tax Returns

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 complete 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. Starting with the tax year 2018, on the new Form 1040 your total capital gains (or losses) would then appear on Schedule 1 and become part of the new schedule's total on Form 1040.

On your Form 8949, 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. According to the myStockOptions Blog, the indexing of the cost basis for inflation may be legislatively considered by Congress or required through an executive order from the president.

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.

Further Resources On ISOs

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 ISO stock is more complex than it is for NQSO shares and restricted stock. 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.