Stock investing brings with it some important tax considerations. One key consideration involves federal income tax and the capital gains tax. Investors need to understand how stock gains and losses impact their tax situation. Taxpayers can deduct some stock losses from their income and from their capital gains, but deductions are limited. Knowing the difference between deductible stock losses and losses that stem from investments that are part of a 401(k) portfolio helps at tax time.
Gains and Losses
A stock gain exists when a stock sells for more than its purchase price plus any commissions paid to brokers. A loss exists when the selling price is less than the purchase price plus broker commissions. Stock gains and losses must be reported in the tax year during which the stocks are sold. The earnings are deemed taxable income and must be reported as income. The total amount received for the sale of the stock counts toward income. This is a point that is sometimes overlooked by investors. In some cases, investors believe they only need to report their capital gain. In reality, they must report both their gain for capital gains tax purposes, and the income from the stock sale for income tax purposes.
Stocks and Taxes
When a stock investor receives a gain from stock, the individual must pay a federal capital gains tax on the earnings. Stock losses, however, can be used to offset or erase a gain. This reduces or eliminates the taxpayer’s liability for capital gains taxes. At the end of the tax year, a taxpayer must add all stock gains and subtract stock losses to determine the total amount of his capital gain. This figure is subject to tax if it is greater than zero. You can deduct capital losses in a tax year in an amount equal to the amount of your stock gains plus $3,000. If your capital loss was more than $3,000 greater than your capital gains, you must carry the excess over to future years.
401(k) Gains and Losses
Stock gains and losses from 401(k) earnings are not reported in the year in which stocks are bought and sold. Instead, 401(k) earnings are only reported in the year in which money is withdrawn. If you receive a distribution from a 401(k), you must pay tax on the distribution, which counts as a portion of your income for the year. None of these earnings, however, are subject to the capital gains tax. You only pay income tax on these earnings. If you have other stock losses from investments that were not a part of your 401(k), you can subtract those losses from your income to offset the amount of tax you owe on any 401(k) distributions.
You can't deduct losses from stock investments tied to a 401(k) from capital gains earned on regular stock investments. The 401(k) earnings are not figured into any tax situation until you receive a distribution. Therefore, you can only deduct losses from regular stock investment trades from your income and from capital gains. You also can claim only stock losses if you sold the stock during the tax year in question. While you cannot deduct 401(k) stock losses from capital gains, you can soften the blow of a 401(k) distribution by deducting any regular stock losses on stocks sold for a loss in the same year that you received a distribution.
Based in Central Florida, Ron White has worked as professional journalist since 2001. He specializes in sports and business. White started his career as a sportswriter and later worked as associate editor for Maintenance Sales News and as the assistant editor for "The Observer," a daily newspaper based in New Smyrna Beach, Fla. White has written more than 2,000 news and sports stories for newspapers and websites. He holds a Bachelor of Arts degree in journalism from Eastern Illinois University.