How Much Tax Do You Owe When Cashing in Stock?

Stock Tax Basis

• Understanding the tax basis of your stock is essential for calculating how much tax you will owe when you cash it in through a sale. The basis of stock is simply the market price you purchase it for plus any commissions you pay to your brokerage company to place the trade. To illustrate, suppose you purchase 1,000 shares of a company at the market price of $5 per share, for a total of $5,000. If you broker charges you $50 to execute the trade, your tax basis in the 1,000 shares is $5,050.
  
  

Taxable Gains

• The significance of your $5,050 tax basis is that the taxable gain equals the price you sell the stock for less your tax basis. However, if you don't sell the entire lot of 1,000 shares, you need to allocate the $50 brokerage commission to each share of stock. For example, if you sell 100 shares, allocate 10-percent of the brokerage commission to the tax basis of those shares. Therefore, your tax basis for 100 shares is equal to $505. And if you receive $400 for those 100 shares, the result is a capital loss of $105.
  
  

Short or Long

• When it's time to report your stock transactions to the IRS, you must first evaluate whether the gain or loss from the stock sale is short- or long-term. Short-term gains and losses result if you own the stock for one year or less before selling it. All stock you hold for more than one year is long-term. The tax implications of your holding period can be significant. The short-term gains you report are subject to ordinary income tax rates, and the losses are only deductible up to $3,000 per year. In contrast, long-term gains are subject to lower rates of tax, but the losses are also only deductible up to $3,000 per year. However, you can use the various gains and losses to offset one another, regardless of the holding period.
  
  

Redemption by Corporation

• It is possible to cash in your stock through redemption rather than a sale. When a corporation redeems your stock, you receive your initial investment back tax-free. For example, suppose you invest in a corporation that doesn't trade on a public stock exchange and the company gives you the option of taking your investment back after one year. If you exercise this option, there is no gain or loss for the IRS to tax since your proceeds equal the stock's purchase price.