Types Of Shares Proceeds
To understand how shares are taxed, it is important that we first understand the types of incomes that investors receive for holding them.
- First, we have the dividends which refer to the portion of profits paid by a company to its shareholders.
- The amount to be paid is determined by the company’s board of directors and paid to a class of its shareholders. They can be issued as cash payments, shares of stock or other property.
- Another form of income results from the sale of shares and is known as capital gains. A capital gain is achieved when the selling price of a share is higher than the buying price. When the selling price of a stock is lower than the buying price, the investor incurs a capital loss.
- Finally, we have the type of dividends that the investor gets for buying a share of an investment portfolio of securities. These types of shares will not be covered in this guide.
- Before we get started on the tax treatment of the above types of incomes, let me clarify that I am not a tax expert and the information given in this post should not be considered as tax advice. This guide is meant to help you get a glimpse of what is expected when filing for shares income.
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Income Tax on Dividends
When it comes to tax on share dividends, every tax jurisdiction has its specifications on when and how investors should file. The US has a long-term view on investments and those who receive their dividends in under 60 days, will have to pay the full income tax amount. Those who wait for after the 60-day period, may have a reduced rate depending on their tax bracket, which is charged at up to 20%.
The income tax band of 0% for those who have a small income also means that there is no tax payable on dividends. In fact, the tax on dividends only kicks in with those in the 25% income tax bracket. This is charged at a rate of 15%, which is also applicable to the 28%, 33%, and 35% tax bands. A sharp jump to 20% takes place in the 39.6% tax band and ensures that the biggest lump of the tax burden is carried by the more-affluent traders.
The lower income brackets ensure traders have a better opportunity of building wealth thanks to the lower tax rates. While there is no dispensation or allowable amount, the taxation really only starts with the higher investment amounts. There are dividends that aren’t taxed at all, but need to fit the parameters, such as IRAs and other government savings and investment initiatives.
Examples in Real Life
An investor receives a dividend income from shares outside of an IRA and a non-dividend income from a service contract. Their taxable income places them in the 33% tax bracket. With no dividend allowance, the taxable dividends are taxed at 15%.
Another scenario is an investor who doesn’t receive a very high income and is currently at the 10% income tax rate. This investor has a tiny share portfolio that doesn’t include any tax-free options such as IRAs. Because the investor is not at the 25% bracket, there is no tax levied on the dividends received from this share portfolio.
It is important to note that even when you have not taxes to pay, you may be required to file especially if you are on self-assessment. A self-assessment filing is meant to determine if the taxpayer is responsible for completing a tax return when needed.
My recommendation is that you consult a tax expert to help you determine if you are required to file and how to go about the process.
Capital Gains tax On Shares Sale
When an investor sells their shares at a price higher than the buying price, they make a capital gain. Just like other types of income, the capital gains are subject to tax depending on the tax jurisdiction.
In the same way as the tax on dividends, the capital gains have a specified amount in which the investor is exempt from being taxed. This amount varies with the tax year and therefore should be clarified with the responsible tax body.
To determine the taxable amount of the capital gains, you need to deduct the tax reliefs for that year plus the losses made in that tax year and those brought forward from previous years. This means that you can carry forward all the losses made in the previous years and set them against gains as they arise in the future.
Also, if you sell shares and use all the proceeds to buy identical investments, you are not required to pay capital gains tax. However, the term identical cannot be loosely translated and therefore it is important to consult a tax expert for clarification.
Another important thing to note is that a share transfer to a spouse does not incur any capital gains tax. However, if the transfer is to any person other than a spouse, it is deemed as a disposal and therefore subject to capital gains tax at the current market value.
An investor buys 500 XYZ shares at $50 per share. After 1 year, the share price has risen to $100 and the investor decides to sell. The capital gains from this sale will be $25,000 ((500*100) – (500*50)). Because this is a long-term capital gain, the IRS would charge the tax at the lower rates as per the schedule. An example would be that those in the 33% bracket would pay 15%. If, however, the shares were sold over the short term, the IRS would consider it a short-term capital gain and tax it at the full 33%.
To calculate the taxable amount, take the capital gain which is $25,000. For the long term investment, the taxable amount is taxed at 15%, which is $3,750. Those who sell on the short term will be taxed at the full 33%. This lumps them with a tax bill of $8,250.
Assume that apart from the sale of shares, the investor sold property with a capital gain of $20,000 and is also employed with an annual income of $50,000. There are personal deductions that are also available that could bring this bill down. The standard deductible is $6,500. To calculate the taxable amount, you will need to add the capital gains from the share sale and the property sale and then deduct the standard deductible.
There are a number of other deductions that taxpayers can investigate that may bring the taxable amount down significantly. Those with disabilities, have children, donate to charities, work for the government, are ex-military, and more should investigate their options. Taxpayers should also investigate the PEP (personal exemption amounts) which starts at $4,150 and reduces on a sliding scale as the individual’s income increases.
What Type Of Shares Income Is Exempt From Tax?
Not all income from shares and investments are taxable, as the US government makes a few products available to those who wish to increase their savings and avoid taxation. TFSAs and IRAs make provision for those who wish to build their wealth without incurring an additional tax burden. There are limitations on these plans and restrictions on the number of plans available to individuals.
Also, while an actual share transfer technically has a taxable amount linked to it, the taxable amount can easily be squashed in the gift provision. While it’s not necessary to pay tax, it’s still important to file it in order for the IRS to have a record.
For Americans who are fortunate to receive restricted shares (RSU) from their employers, there is no special tax rate. This is because the IRS views these shares as a form of compensation, which means that once the amount is vested, taxpayers are liable at their full income tax rate. The shares have no value until they’re vested, which could be a risky exercise for employees. On the flip side, this could be a marvelous opportunity for those with unvested shares in companies that spike within the next few years.
Understand Tax Requirements
Whether you are an experienced or a new investor, understanding the tax requirements for your jurisdiction will help you determine the best ways to reduce your tax bill.
While it is always prudent to engage a tax professional to guide you on the details, it is important to have a basic understanding of what is expected and what you need to do to be on the safe side of the law. Going against the rules set by your tax jurisdiction whether knowingly or unknowingly can result in hefty fines.
When it comes to taxes on shares sale, there are many ways an investor can lower their tax bill and for these, it is best to engage an experienced tax expert. When looking to invest in the stock market, the tax implications should be among the top areas to address for investors and should review every now and then to ensure adherence and also revise tax avoidance strategies.