When you open an account at a brokerage firm that’s not given special tax treatment (as an IRA would be, for example), your account is usually called a taxable brokerage account. The name suggests that the account is going to be taxed (seems pretty obvious, right?). But it may come as a surprise that despite this poor marketing, you may actually not have to routinely pay taxes on this type of investment plan.
Here’s what you need to know about the rules.
A taxable brokerage account doesn’t mean you’ll always owe the IRS
The good news for people with taxable brokerage accounts is that you aren’t just automatically going to have to pay the IRS money — even if the assets in your account make a profit.
Read more: we researched free tax software and put together a list of the best options here
In fact, you only have to pay taxes if:
- You sell assets within the account at a profit (that profit is referred to as a “capital gain”)
- You earn dividends on assets held in the account
- You are paid interest on cash in the account
In other words, you are taxed if you actually earn income over the course of the year — not just on paper, but in reality. This means, for example, that if you invest $1,000 in a stock that does really well and it turns into $10,000 but you don’t sell it, you would not pay a single dollar in taxes. You would only be taxed if and when you sell and that $10,000 becomes yours.
It’s important to know that you don’t pay taxes on gains that you haven’t realized because you haven’t actually earned the money yet. Your investments could perform badly in the future and you could lose the money, so it wouldn’t make sense to tax you on gains before you sell. Since dividends and interest are paid out and deposited into your account and become yours, though, you are taxed on that income as it comes.
You’re also subject to favorable tax rules
Even if you do owe taxes on the money in your investment account, the good news is that you may not have to pay that much. There are two reasons for that.
- You can offset your capital gains (profits earned) if you have capital losses (you sold assets at a loss). So if you make $100 on one stock and lose $100 on another and you sell both during the year, your $100 losses would offset (or be subtracted from) your gains and you’d end up with no actual income to declare.
- There are favorable capital gains tax rates that apply if you’ve owned the assets for more than a year. Depending on your income and filing status, the long-term capital gains tax rate that applies could be as low as 0%. You can find out your capital gains tax rate to see exactly how much you’d pay in taxes. If you don’t own your assets for a year or longer, though, you’d be taxed at your ordinary tax rate, so you’ll probably want to try to avoid that and hold onto your investments.
If you did sell at a profit or earned interest or dividend income, most online tax software programs are set up to allow you to enter this information when you do your taxes. Your brokerage firm will send you the forms you need showing how much income you have to declare, and you can enter this data in the right boxes (or give the forms to your accountant to handle it if you don’t do your own taxes).
And remember, the good news is that if you do owe taxes, that’s because you made money — so it’s not the worst thing in the world to write that check to the IRS.
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