How capital gains work.

When you sell an asset at a price higher than you paid to acquire it, the profit is referred to as “capital gains.” If you owned the asset for one year or less, the capital gains are considered “short term.” Capital gains on assets that are sold after you’ve owned them longer than one year are considered “long term.” Short-term gains and long-term gains are taxed at different rates.

Long-term capital gains.

A capital gains tax rate of 15% applies to qualified dividends and the sale of most appreciated assets held over one year (28% for collectibles and 25% for depreciation recapture) for single filers with taxable income up to $418,400 ($470,700 for married couples filing jointly).

For example:

A married couple with $470,700 of taxable income + an additional $100,000 in long-term capital gains and qualified dividends:
The entire $100,000 is subject to the 20% rate.
A married couple with $400,000 of taxable income + $100,000 in long-term capital gains and qualified dividends:
$70,700 of the additional amount is taxed at 15% and $29,300 is taxed at 20%.

Taxpayers whose taxable income falls in the top 39.6% ordinary tax bracket ($418,400 for single filers; $470,700 for married couples filing jointly or qualifying widow[er]s in 2017) are taxed at the top capital gains tax rate of 20%.

Taxpayers with income below the 25% marginal bracket pay no federal tax on long-term capital gains.

Short-term capital gains:

Appreciated assets held for less than a year receive no special treatment and are taxed at your ordinary income tax rate.

Net investment income tax.

Another tax to be aware of is called the net investment income tax is a tax of 3.8% on certain net investment income and applies to single filers whose modified adjusted gross income (AGI) exceeds $200,000 per year, and married couples filing jointly whose AGI exceeds $250,000 per year. In effect, this means a top ordinary federal tax rate of 43.4% and a top federal long-term capital gain tax rate of 23.8%

How dividends work.

In simple terms, dividends are your share of the profits made by a company in which you own stock. The board of directors of a company can choose to distribute a portion of the company’s earnings to a class of its shareholders. Dividends can be issued as cash payments, shares of stock, or other property.

When dividends are issued to you, they’re typically considered taxable income.

Ordinary dividends

Ordinary (taxable) dividends are the most common type of distribution from a corporation or a mutual fund. They are paid out of earnings and profits and are treated as ordinary income. This means they are not capital gains. You can assume that any dividend you receive on common or preferred stock is an ordinary dividend unless the paying corporation or mutual fund tells you otherwise.

Qualified dividends

Qualified dividends are ordinary dividends paid during the tax year by domestic corporations and qualified foreign corporations. which you held for at least a specified period of time. These dividends are subject to the same 0%, 15%, or 20% maximum tax rate that applies to long-term capital gains. They will be shown in box 1b of the Form 1099-DIV you receive.

2017 tax rates.

When viewing the table below, remember that short-term gains are taxed at the same rate as your ordinary income.

Single

Over But not over Tax rate on ordinary income Tax rate on qualified dividends and long-term capital gains
$0 $9,325 10% 0%
$9,325 $37,950 15% 0%
$37,950 $91,900 25% 15%
$91,900 $191,650 28% 15%
$191,650 $416,700 33% 15%
$416,700 $418,400 35% 15%
$418,400 -------- 39.60% 20%

Married filing jointly / Qualifying widow or widower

Over But not over Tax rate on ordinary income Tax rate on qualified dividends and long-term capital gains
$0 $18,650 10% 0%
$18,650 $75,900 15% 0%
$77,400 $156,150 25% 15%
$153,100 $233,350 28% 15%
$233,350 $416,700 33% 15%
$416,700 $470,700 35% 15%
$470,700 -------- 39.60% 20%

We're here to help

Clients of independent investment advisors: You may also contact your advisor or call Schwab Alliance at 800-515-2157.