How do taxes work with investments?

Welcome to the weeklyish Operation the Hustle Newsletter, where we break down tax and finance concepts into plain English that anyone can understand. Today, we are covering tax on stock market investments, what you pay tax on, when you pay it, how much tax you pay, and how to lower that tax bill, or how to avoid it all together!

When you invest in the stock market, it’s not just about picking the right investments, you also need to consider the tax implications that are involved. Depending on how long you hold your stock, the type of account its held in, when the money is withdrawn, and what your profit & loss is for the year, taxes can vary wildly!

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What is taxed when you invest in stocks?

When it comes to stock market investing, the taxes involved will generally come from 3 main categories:

1. Capital gains - When you sell a stock for a profit

2. Dividends - When a company cuts you a share of the company profits for simply owning shares of that company (or funds)

3. Early Withdrawals - When you pull money out of a retirement account ahead of retirement age and no tax exception applies

Like I said, the taxes involved in investing can vary wildly, so lets take a deeper dive!

When you won’t get taxed on your investments

• Roth Accounts (like IRA’s and 401k’s): tax free accounts

  While you don’t get a tax deduction for contributions, one of the main benefits of a Roth IRA is that capital gains realized, and dividends received, are generally tax free! This is the case unless you take a distribution from the account ahead of retirement age (generally 59 ½). This is a HUGE benefit because instead of paying tax on any gains or dividends each year, you’re able to reinvest the money and let it keep growing.

• Traditional Retirement Accounts (like IRA’s and 401k’s): tax deferred accounts

  For these accounts you may get a tax deduction on contributions, deductibility on some accounts like the IRA are subject to income limitations. While you may get a tax deduction on contributions, keep in mind that this is simply a tax deferral. This means that you WILL likely get taxed down the line when the money is distributed, either at retirement or as an early withdrawal. The main benefit here is taxes are pushed to a later date giving your money more time to grow.

You can have capital gains or earn dividends within these accounts without getting hit with taxes. If the account is a Roth account, and you don’t take any distributions until retirement, it’s possible those gains and dividends will never be taxed. If the account is a traditional account, and you don’t take distributions ahead of retirement, you’ll most likely see the tax bill when you withdrawal funds at retirement.

When will you get taxed on investments

• Taxable Brokerage Accounts: taxable accounts: these are considered taxable accounts. These accounts are not specifically meant to be retirement accounts. They will not come with a tax deduction on contributions nor tax free distributions at retirement. Instead, these are kinda like “pay as you go” accounts. All this means is that you’re tax on capital gains as they are realized and you’re taxed on your dividends as they are paid out to you. It doesn’t matter if you pull the money of the account or not.

• Early withdrawals: this is a penalty tax, generally 10% for retirement accounts, that you will see if you pull money out of an account before you’re supposed to. For 401k’s and IRA’s, this is 59 1/2. Other investing accounts, like the HSA, have a 20% penalty tax if you are pulling funds out of the account for expenses other than qualified medical expenses. There are special rules for Roth IRA’s that may allow you to access contributions tax free, but that does not apply to capital gains.

How much tax you have to pay

One of the main factors in calculating how much tax you have to pay on capital gains is based on the period of time you actually held the asset. Gains, if taxable, will generally be taxed as either short term capital gains or long term capital gains.

Short term capital gains: this treatment applies to gains from assets held one year or less when it was sold. Unfortunately, these gains will be treated as ordinary income (this means it gets taxed the same way as your W-2 or 1099 income). Ordinary income tax rates can be as high as 37% in 2025.

Long term capital gains: this treatment applies to gains from assets held for more than one year. These gains are generally taxed at the much lower rates of 0%, 15%, or 20% based on your income, they’re called preferential tax rates for a reason. For most people, their long term capital gains tax rate will be no higher than 15%. (For more info on this, read IRS Topic no. 409)

Pro tip: It’s generally a good idea to hold for the long haul! you’ll get to keep more money in your pocket since you’ll pay less tax.

How to lower your capital gains taxes

1. Hold Long Term - like I just mentioned above, holding assets for more than 1yr means you get to enjoy the benefits of preferential tax rates. Try to avoid taking gains that will be subject to short term capital gains tax rates (which will likely be higher)

2. Tax Loss Harvesting - when it comes to capital gains, you are taxed on your net gains for the year. This generally means that you are able to take any losses you’ve realized to offset any gains. Intentionally selling stocks at a loss to offset capital gains is called tax loss harvesting. You can think about it like your losses are cancelling out some, or all, of your gains. If you don’t use all your losses one year, you can carry them forward to offset capital gains in a future tax year

3. Avoid Selling During High Income Years - If you’re in a high income tax bracket one year, consider waiting until you’re in a lower income tax year to sell an asset. This would allow you to avoid paying tax at a higher rate and shift into a lower tax rate year. This may even extend your holding period so you shift into a long term capital gains tax rate

4. Donate Stocks to Qualified Charities - Did you know you can donate stocks and potentially avoid paying capital gains taxes on appreciated value? Additionally, you may be entitled to deduct the FULL market value of the donation to charity. This means you may be able to write off what the stock is worth when you donate it, not just what you paid for it! For more info on this read IRS Publication 506.

I hope you found this information useful as you are on your wealth building journey. See you next week!

-Neyra

*** Please remember that while I am a CPA, I am not YOUR CPA. This content is for educational purposes only, please seek the advice of tax, legal, and finance professionals on any financial decision you contemplate***

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