How Taxes Work in a Brokerage Account (and How to Manage Them)
If you’ve ever wondered how brokerage accounts are taxed, you’re not alone. It can be confusing, but understanding it can save you money and stress.
Let’s break it down step by step: what’s taxed, when it’s taxed, and smart ways to manage it.
Understanding the Basics: What Is a Brokerage Account?
A brokerage account can be a great way to invest in things like stocks, bonds, mutual funds, and ETFs.
A brokerage account can also be referred to as:
● A taxable account
● A taxable brokerage account
● An individual account (if it’s owned by one person)
● A Joint account or a JTWROS account
● A TOD (Transfer on Death) account
All of the above could be labels assigned to this type of account, depending on how the institution displays the name of the account.
Unlike tax-advantaged accounts such as IRAs or 401(k)s, brokerage accounts are taxable. That means Uncle Sam wants a piece of your gains, sometimes in complicated ways.
Knowing what triggers taxes helps you plan better.
Capital Gains: Short-Term vs. Long-Term
One of the main tax events in a brokerage account is realizing a capital gain.
● Short-Term Capital Gains. These occur when you sell an investment held for one year or less. They're taxed as ordinary income, so your regular income tax rate applies.
● Long-Term Capital Gains. If you hold an investment for more than one year before selling, the gain qualifies for a lower tax rate. Depending on your income, you’ll pay 0%, 15%, or 20%.
Why It Matters
Holding an investment for more than a year can significantly reduce your tax liability, especially if you’re in a higher tax bracket.
Dividends: Qualified vs. Ordinary
Dividends are another source of taxable income in a brokerage account.
● Qualified Dividends. These meet specific IRS requirements and are taxed at the lower long-term capital gains rate.
● Ordinary Dividends. These don’t meet the criteria and are taxed at your ordinary income tax rate.
Management Tip
Understand which of your dividends are qualified. It can make a noticeable difference on your tax bill.
Other Taxable Events: Interest, Mutual Funds, ETFs
● Interest income from bonds or cash equivalents is taxed as ordinary income.
● Mutual funds may distribute capital gains even if you didn’t sell anything yourself. Those are taxable in the year they're distributed.
● ETFs are generally more tax-efficient, but they can still create taxable events, particularly when you sell shares.
Tax-Loss Harvesting: A Smart Strategy
One of the more powerful tax tools available to investors is tax-loss harvesting. This involves selling investments at a loss to offset realized gains.
You can use losses to offset gains dollar for dollar. If your losses exceed your gains, you can deduct up to $3,000 of those losses against ordinary income each year. Any excess loss carries forward into future years.
The Wash-Sale Rule
If you sell an investment at a loss and buy a “substantially identical” one within 30 days before or after, the loss is disallowed. This is known as the wash-sale rule. Avoid it to ensure your losses are deductible.
Tax-Gain Harvesting: Taking Advantage of Low-Income Years
Tax-gain harvesting is a lesser-known but highly effective strategy. It involves intentionally realizing long-term capital gains in a low-income year, often paying little or no tax on the gain.
How It Works
The IRS applies a 0% tax rate on long-term capital gains for individuals with taxable income below a certain threshold. Be sure to verify what these thresholds are for the year you are in.
If your income falls below these thresholds, you can sell appreciated investments and pay no federal tax on the gains.
Why It’s Smart
By harvesting gains when your tax rate is low or zero, you reset your cost basis. This can reduce the tax hit on future sales if you're in a higher tax bracket later on.
For example, if you bought a fund for $10,000 and it’s now worth $15,000, you could sell it in a low-income year, realize the $5,000 gain tax-free, and immediately rebuy the same fund. There’s no wash-sale rule for gains. Your new cost basis is $15,000, which lowers future taxable gains.
When to Use Tax-Gain Harvesting
This strategy is especially useful in years when:
● You're in between jobs or on a sabbatical
● You're recently retired and haven’t started Social Security or RMDs
● You're expecting higher income in the future
It’s a forward-looking way to reduce lifetime tax liability, not just taxes for the current year.
Warning: be aware that capital gains can affect other things, like ACA premium tax credits. Even if you pay no income tax on a capital gain, be sure to review how it can affect other areas of your financial life.
Estimating and Paying Taxes on Brokerage Earnings
You’ll need to account for your brokerage income and gains when filing your taxes. Here are the key forms involved:
● Form 1099-B: Reports proceeds from brokered sales, including cost basis and gain/loss
● Form 1099-DIV: Reports dividend income
● Form 1099-INT: Reports interest income
● Form 8949 and Schedule D: Where gains and losses are calculated and summarized
If you realize a significant amount of income from a brokerage account, consider adjusting your estimated tax payments to avoid penalties.
Tax-Efficient Planning Tips
1. Hold Investments Long Enough
Avoid selling before the one-year mark when possible to benefit from long-term capital gains rates.
2. Choose Tax-Efficient Investments
Consider ETFs, municipal bonds, and index funds, which tend to generate fewer taxable events.
3. Use Loss and Gain Harvesting Strategically
Offset gains with losses, and don’t overlook the power of harvesting gains in low-income years.
4. Time Your Transactions
If you expect a higher tax bracket next year, consider accelerating gains this year or delaying losses until they’re more valuable.
5. Practice Smart Asset Location
Hold tax-inefficient assets (like taxable bonds) in tax-advantaged accounts. Hold stocks and equity funds in taxable brokerage accounts where lower long-term rates apply.
6. Reinvest With Intention
If you’re reinvesting dividends or capital gains distributions, make sure it aligns with your broader tax and investment strategy.
Keeping Good Records
To manage your brokerage account taxes effectively, stay organized. Keep detailed records of:
● Purchase dates and cost basis
● Sale dates and proceeds
● Dividends and interest received
● Realized gains and losses
● Reinvestment activity
Good recordkeeping not only simplifies tax season, it can also protect you in case of an IRS audit.
Final Thoughts
Taxes on brokerage accounts can be complex, but they’re manageable with the right strategies. Whether you're using tax-loss harvesting, gain harvesting, or simply holding long-term, small decisions can lead to significant tax savings over time.
If your investment activity becomes more involved, or if you’re not sure where to start, it might be worth working with a financial advisor or tax professional.
The right guidance can help you make informed choices, reduce your tax liability, and invest with more confidence.
Let’s talk. Book a meeting here.
Disclosures: FMD Wealth Advisors LLC (“FMD Wealth Advisors”) is a Registered Investment Adviser.
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