Is a Brokerage Account Taxable? How the Taxes Work
Navigate the tax landscape of your brokerage account. Understand how investment income is taxed and what you need to report.
A brokerage account serves as a financial vehicle where individuals can hold various investments, such as stocks, bonds, mutual funds, and exchange-traded funds (ETFs). These accounts provide a platform for investors to buy and sell securities, offering flexibility in managing a diverse investment portfolio. Generally, any income generated or gains realized within a non-retirement brokerage account is subject to taxation in the year it occurs. The account itself is not taxed, but the activities and earnings within it can trigger tax obligations.
Understanding Taxable Versus Tax-Advantaged Accounts
A fundamental distinction exists between standard, taxable brokerage accounts and tax-advantaged investment accounts. In a taxable brokerage account, earnings and gains are typically subject to taxation annually or when realized through a sale.
In contrast, tax-advantaged accounts, such as Individual Retirement Accounts (IRAs), 401(k)s, Health Savings Accounts (HSAs), and 529 plans, offer specific tax benefits. These benefits often include tax-deferred growth, where taxes are only paid upon withdrawal in retirement, or tax-free withdrawals under certain qualifying conditions. For example, contributions to a traditional IRA may be tax-deductible, and investment growth is not taxed until retirement withdrawals begin. Roth IRAs, funded with after-tax dollars, allow qualified withdrawals to be entirely tax-free in retirement. These accounts are designed to encourage long-term savings by providing a tax shelter for investment growth.
Types of Taxable Income in Brokerage Accounts
Brokerage accounts can generate several types of income and gains that are subject to taxation.
Dividends represent a portion of a company’s earnings distributed to its shareholders. Both qualified and non-qualified dividends are considered taxable income within a brokerage account.
Interest income is another common form of taxable earnings derived from various securities held in a brokerage account. This includes interest from bonds, money market accounts, and other debt instruments.
Capital gains arise when an investment is sold for more than its original purchase price, known as its cost basis. It is important to differentiate between realized gains, which occur only after an asset has been sold, and unrealized gains, which are merely “paper” profits on investments still held. Only realized capital gains are subject to taxation.
How Brokerage Account Income is Taxed
Interest income and non-qualified dividends are typically taxed at an individual’s ordinary income tax rates, similar to wages or salaries. These rates can range from 10% to 37% depending on the taxpayer’s income bracket.
Qualified dividends, however, receive preferential tax treatment and are taxed at the lower long-term capital gains rates. For a dividend to be considered qualified, specific criteria must be met, including holding the stock for a defined period. These preferential rates are typically 0%, 15%, or 20%, depending on the taxpayer’s taxable income level.
Short-term capital gains, which result from selling an asset held for one year or less, are taxed at ordinary income tax rates. Conversely, long-term capital gains, arising from the sale of an asset held for more than one year, are taxed at the more favorable long-term capital gains rates (0%, 15%, or 20%). Higher-income taxpayers may also be subject to the Net Investment Income Tax (NIIT), an additional 3.8% tax on certain investment income, including capital gains, dividends, and interest. This tax applies to individuals, estates, and trusts with income above statutory threshold amounts.
Reporting Brokerage Account Activity on Your Taxes
All brokerage account activity must be reported to the Internal Revenue Service (IRS). Brokerage firms facilitate this process by issuing various tax forms that summarize the year’s investment activity.
Form 1099-DIV reports dividends and distributions received, distinguishing between ordinary and qualified dividends. Form 1099-INT details interest income earned from various interest-bearing securities. For sales of securities, Form 1099-B is provided, summarizing proceeds from broker and barter exchange transactions, including sales of stocks and funds. This form includes the gross proceeds and, in many cases, the cost basis of the sold assets.
This information is then reported on an individual’s Form 1040, primarily through associated schedules. Interest and ordinary dividends are typically reported on Schedule B (Interest and Ordinary Dividends). Capital gains and losses from Form 1099-B are first detailed on Form 8949 (Sales and Other Dispositions of Capital Assets). The totals from Form 8949 are then transferred to Schedule D (Capital Gains and Losses).