Do You Pay Taxes on a Brokerage Account?

A brokerage account is an investment vehicle where individuals can buy and sell various securities like stocks, bonds, and mutual funds. Unlike certain retirement accounts, income generated in these accounts is generally subject to taxation. Understanding the tax implications is important for investors.

Understanding Taxable Income

Income earned within a brokerage account typically falls into several categories, each with distinct tax treatments. Dividends represent a portion of a company’s earnings distributed to shareholders. These are categorized as either “ordinary dividends” or “qualified dividends.” Ordinary dividends are taxed at an individual’s regular income tax rates, which can range from 10% to 37%.

Qualified dividends receive more favorable tax treatment, taxed at the lower long-term capital gains rates of 0%, 15%, or 20%, depending on the taxpayer’s income level. To qualify, specific holding period requirements must be met, meaning the stock must be held for more than 60 days during a 121-day period. Interest income, generated from sources like bonds or cash held in money market accounts, is taxed as ordinary income.

Capital gains and losses arise from selling an investment for more or less than its original purchase price. A “short-term capital gain” occurs when an asset is held for one year or less before being sold; these gains are taxed at ordinary income tax rates. A “long-term capital gain” results from selling an asset held for more than one year, taxed at the lower rates of 0%, 15%, or 20%.

Calculating Capital Gains and Losses

The calculation of capital gains or losses hinges on the “cost basis” of an investment. Cost basis is the original purchase price of an asset, plus any commissions or fees paid to acquire it. A capital gain or loss is determined by subtracting this cost basis from the net sale price of the asset.

When an investor sells only a portion of their holdings, various methods can be used to determine the cost basis for the sold shares. The “First-In, First-Out” (FIFO) method assumes the oldest shares purchased are sold first. “Specific Identification” allows investors to choose which specific shares are sold. The “Average Cost” method, primarily used for mutual funds, averages the cost of all shares.

The “wash sale rule” applies when realizing capital losses. This rule disallows a tax deduction for a loss if an investor sells a security at a loss and then buys a substantially identical security within 30 days before or after the sale date. If a wash sale occurs, the disallowed loss is not immediately deductible but is added to the cost basis of the newly acquired security. This adjustment defers the tax benefit until the new shares are sold.

Reporting Brokerage Account Activity

Brokerage firms provide tax forms summarizing an investor’s annual activity for tax reporting. Form 1099-B reports sales of stocks, bonds, and other securities. This form includes gross proceeds and, for “covered securities,” provides the cost basis, which is used for calculating capital gains or losses.

Dividends and distributions are reported on Form 1099-DIV. This form separates ordinary dividends (Box 1a) from qualified dividends (Box 1b) and also reports capital gain distributions from mutual funds. Interest income earned within the brokerage account is detailed on Form 1099-INT.

The information from these forms feeds into an individual’s tax return. Interest and ordinary dividends are reported on Schedule B (Form 1040). Capital gains and losses from the sale of securities are detailed on Form 8949. This form categorizes transactions as short-term or long-term, and totals are then transferred to Schedule D (Form 1040), where the net gain or loss is calculated and reported. The Internal Revenue Service (IRS) receives copies of these forms directly from brokerages.