Tax implications

Investors have two main ways to earn a return on stock:

• Dividends
• Capital gains

Stock taxation focuses on these two sources of return. You’ll want to understand how each is taxed and what the Internal Revenue Service (IRS) may require you to report and pay.

Dividends

A cash dividend is income received from common or preferred stock. Investors can also receive dividends from funds (e.g., mutual funds) that pass through income earned by the investments held in the fund’s portfolio.

Dividends are often taxed at lower rates than ordinary income, but the rate depends on whether the dividend is qualified or non-qualified.

Qualified dividends:

• Taxable at 15% for most investors

• Taxable at 20% for investors at the highest income tax brackets

Non-qualified dividends:

• Taxable up to 37% (based on income tax bracket)

Dividends can be qualified or non-qualified, and that classification determines the tax rate. Dividends are qualified if the issuer meets certain requirements and you hold the investment for a required period of time (you don’t need the specific rules here). Most dividends investors receive are qualified.

Qualified dividends are taxed at 15% for most people, while investors in the two highest income tax brackets pay 20%. Your reported income affects your marginal tax bracket: as income increases, the tax bracket can increase. Only a small portion of taxpayers fall into the highest brackets.

A common situation where you’ll see non-qualified dividends is with real estate investment trusts (REITs) (covered later in these materials). Because the income is taxed at higher rates, REITs generally need to offer higher returns to attract investors. Non-qualified dividends are taxable up to 37%, depending on the investor’s tax bracket.

Corporate investors can receive additional tax benefits compared with individual investors. Under the corporate dividend exclusion rule, corporations can exclude (and therefore avoid paying taxes on) a portion of dividends they receive:

Corporations can avoid paying taxes on:

• 50% of dividends if owning less than 20% of the issuer’s common stock
• 65% of dividends if owning 20% or more of the issuer’s common stock

Corporations often maintain brokerage accounts to invest excess cash. As a result, they may own shares of other companies. For example, assume General Electric (GE) owns a small portion of Coca-Cola (KO) stock. If Coca-Cola pays a $100,000 dividend to GE, GE pays taxes on only $50,000. If GE owned 20% or more of Coca-Cola, it would pay taxes on only $35,000 of the $100,000 dividend payment (a 65% exclusion).

Dividends are reported annually on tax form 1099-DIV. Brokerage firms send these forms to their customers and to the IRS. The form shows the amount of dividends received and whether they were qualified or non-qualified.

For a dividend to appear on a given year’s 1099-DIV, it must be paid in that year. For example, if a dividend is declared in 2025 but paid in 2026, it is reported on the 2026 1099-DIV.

Capital gains & losses

A capital gain occurs when an investor sells a security for more than its original cost. This is the “buy low, sell high” idea. Selling a security for less than its cost creates a capital loss.

A gain or loss is realized when the position is closed out (long securities are sold, or short securities are bought back). To determine the gain or loss, investors compare cost basis to sales proceeds.

• Cost basis is the total amount paid to buy the security, including any commission.
• Sales proceeds is the total amount received when selling the security, minus any commission.

In other words, cost basis is what you paid in total, and sales proceeds is what you received in total.

To see how this works, walk through this example:

An investor purchases shares of ABC stock at $50 while paying a $2 per share commission. Several months later, the stock is sold for $70 while paying another $2 per share commission. What is the cost basis, sales proceeds, and capital gain or loss?

Can you figure it out?

Capital gains can be long-term or short-term.

Long-term capital gains apply to securities held for longer than one year. Technically, the holding period must be one year and one day to qualify as long-term. Long-term capital gains are taxed similarly to qualified dividends: 0%, 15%, or 20%, depending on annual income.

Short-term capital gains apply to securities held for one year or less. Short-term gains are taxed at the investor’s ordinary income tax rate, which can be as high as 37% (similar to non-qualified dividends). Because of the lower tax rates, investors generally prefer long-term capital gains.

Capital gains are reported on form 1099-B (B stands for brokerage proceeds). Each year, brokerage firms report customers’ capital gains and losses to the IRS. If an investor has more gains than losses (a net capital gain), taxes are owed. A net capital loss can be used as a deduction.