Basic Rules of Taxation of Stocks
Just like other income you earn income from stock trading and holding also result in tax consequences. As a beginner you may be confused and scratching you head about the dates and rates of tax that you are required to pay. This article is dedicated to the knowledge of tax consequences due to holding of stocks and shares of companies. It is important that you quickly to through this topic to plan your tax expense. One thing to keep in mind that the tax avoidance is legal but tax evasion is illegal and it is a criminal act. Our focus is on avoidance and minimization of tax expense and not on the tax evasion.
Tax planning of your investments helps you can maximize your after tax income earnings. It is important that you manage what you left after paying all the taxes along with the quantity of investments you held. You survive your lifestyle on your after-tax income, therefore it is good to know briefly about the taxes to maximize your future wealth.
Specifically, it is important for you to learn about the following:
- How your investments are taxed
- Time period and duration of holding investments
- Comparisons of investments in the light of after tax returns
Types of income from Stock Investment
You earn two types of income from stocks. One income arise when you purchase and resale the shares of companies. The other one is the dividend income both quarter and final dividends at the yearend after closing all the affairs of the company for ta given year. The profit you earn from selling your shares is termed as Capital Gain.
Capital gain tax is payable when you realize the increase in the value of your stocks and shares. This capital gain is taxable under taxation laws, and this tax is known as capital gain tax. The amount of capital gain tax vary according to holding period, type of security, whether quoted or unquoted on stock exchange. Tax rules offer many exemptions and rebates on different shares you held and also according to your age. For complete knowledge and awareness I recommend you to go through the tax rules of your country, as the taxes for the same is different in UK while the US has more lenient tax policies about income from stock investments.
In the above example investor sold half of his holdings as he saw good rise in share prices. He kept half of the investment and at year received dividends from the issuer company. He need to pay two type of taxes at the government prescribed rate on $2,500 and dividend income of $125 separately. The shares held as at year end are not taxed because the investor has not sold the same and the valuation increase is not realized by him. It is considered as unrealized income and it is not taxed by the authorities. You may get exemptions and tax rebated if you own the shares in stock options, listed shares, and holding them for more than one year.
Tax saving tips are important because you can save good amount of money by following them in legitimate manner.
Founder & CEO at Unicorn Bay. Masters Degree in CAD/CAE developed several portfolio optimizing products for banks. Has a great experience in investments and math behind the Portfolio Risk Management.