- Hey guys, Toby Mathis here,
and a question we get a lot is the tax treatment of
stocks and option trading. So the first thing to remember
whenever you're involved in the purchase and sale of
anything is that there's more than likely gonna be a tax
implication upon the sale of that asset, and that's no
different than with stocks or options, bonds for that matter. If you are buying stock, it
is considered a capital asset. So when you purchase
it, you start something called a holding period. So if I buy shares of ABC
inc. on January first, that starts its holding period if the market was open on January first. I should probably be more clear. How about we purchase it on December 31st, assuming the market's open that day? So the holding periods
are one year or less or more than one year. So one year or less
means I hold that stock for an entire year and I sell it on December 31st the following year. That would still be short-term
'cause it's one year or less. If I wait until January
of the following year and I manage to get it just
a day over the 365 days, then I would be long-term capital gains. So the thing you have to
remember is one year or less, you're short-term, more than
one year, you're long-term, and there's a few little
exceptions on different things, but we're just gonna
say as a general rule, that's the easiest thing to remember, short-term capital gains
are one year or less and they are taxed at
your ordinary bracket. I'm just gonna assume
everybody is buying it for their own accounts. This is not the same thing for IRAs, 401ks 'cause they're tax-exempt,
but for you as an individual or you through an LLC that's
taxed as a disregarded entity or a partnership, it's
blowing onto your return, it's gonna be taxed as capital gains. If it's one year or less, it's short-term and it flows into your
ordinary tax bracket, just like you made money at anything else. It is not subject to
social security taxes, but it is subject to federal taxes and quite often state taxes
at your ordinary rate. So if you're in the 37% tax
bracket and you hold a company, let's say I buy ABC and I
sell it six months later, those gains are gonna be
taxed at my 37% tax bracket. Now, here's an exception. An exception is if I'm
doing futures contracts, in which case futures are always taxed 40% short-term capital gains, 60% long-term. So 40% would flow into
the 37 and then the rest of it would be long-term capital gains, and the way it works is
if you hold something more than a year or if you're
doing futures, the portion that is long-term capital
gains, if I hold it longer than a year, I am now into
long-term capital gains, it is taxed at either
zero, 15, or 20% depending on your taxable income that you have. So if you are in the 37% tax
bracket, I can safely assume that you're gonna be
in the highest category for long-term capital gains which is 20%. So if I buy ABC on December
31st of, let's say 2021, and I sell it at the end
of January, of not 2022, but of the following year, so
I held it more than a year, so I'd be in 2023, then I'm
in long-term capital gains. I'm gonna be taxed at zero, 15, or 20%, depending on my income, and
it's basically like this. Like this year, I'm sitting here in 2021, you're right around $80,000
married filing jointly. If you're beneath that, if the gain is underneath that category, you're in 0%. So if I make $50,000 a year
after all my standard deductions and everything, so I have
taxable income at 50,000 and I make $10,000 of
long-term capital gains, it'll be taxed at 0%. That's why people love the stock market. You get into those long-term capital gains and they're fantastic. Short-term capital gains, flip it around, maybe not so fantastic 'cause
it depends on my tax bracket, and I still wouldn't get beat up too bad. I'd probably be, what,
looking at 22% tax bracket or something around there. So it's not horrible even
on the short-term side if I don't make too much money. The problem is if you're making good money and you also have stock
gains, then all of a sudden, it's starts creeping up,
and just giving ideas is if you're somebody who is
making, six, $700,000 a year and you have long-term capital
gains, it's 20% federal tax. You also have a net investment income tax of 3.8 plus you have your state. If you're in a state like
California where it's 13%, well, now you have to
add all those things up and you're, what, in a
36, 37% tax bracket again, and then there's talks, right
now as I'm sitting here, the Biden administration
has not come out yet on long-term capital
gains, but they're talking about bumping it up to 39.6% for people who make over $1 million. So all that comes in, but
what I want to stress is that these are capital
assets, so when you sell a capital asset in a year or less, you're gonna be at
short-term capital gains. When you're a year and above,
it's long-term capital gains. Now we go into the
realm of selling options or buying options. I'm just gonna focus in
on the sale of options 'cause buying options,
we're not so worried about on purchasing. That's not gonna be taxable. What's going to be, and we'll
say this, the option period, whether I am selling and receiving money or whether I am buying, I
have a holding period now, but I have no taxable event there. So even when I bought it,
it's not a taxable event til I either sell it or it
expires or I'm assigned shares. So if I am selling calls, for
example, I sell an option. So let's say I own ABC at $10
and I sell somebody the right to make me buy it, or that
I sell somebody the right to buy it at $11. So I'll just walk you through this. Because it's in or out of the money, meaning that I'm not deep in the money, I'm selling something more
than what that company's worth, it does not affect my holding period of the underlying stock. So if I buy ABC, selling covered calls in and of itself will not destroy me or make me toll my holding
period or anything like that. You don't have to worry about that. Some of you guys are like, huh? And I'm like, just don't worry about it. If I buy it at $10 and I sell
somebody a call to buy it at $11 and let's say I give
them six months to purchase it and they give me $1, I
now have the $10 company and I have another dollar. I do not have to pay
tax on that dollar yet. That is not a taxable transaction. That $1 that I received becomes taxable when I either buy back the option, it expires, or the stock is assigned. So let's say the stock goes up to $13 and I have that $1 I've
received for selling the option. The individual who purchased
the option exercises it. So they have the right to buy it at $11. So I get $11. So I bought it for 10, I'm
getting 11, so I get $1 of gain, and I have another dollar
of the option income, and I'm gonna look at the holding period of the underlying stock to determine what that taxable amount is. I have received $2 more
than what I paid for it and we're gonna look
at the holding period. If the holding period is more than a year, that should be treated as
long-term capital gains. If the holding period is a year or less, it's gonna be short-term capital gains and that's gonna dictate
how it flows onto my return. So I know this stuff gets a
little bit muddy, and especially if you're doing straddles
there's even different rules, but I'm just trying to
give you the general rule and then we figure out what you are doing to determine whether there's anything in particular you need to be aware of. So if you're doing forex, that could be ordinary income 100%. If you're doing 988 elections,
it could be ordinary loss which we'll get into here in a second. If you're doing futures, if
you're doing 1256 contracts, et cetera, you could be
looking at 60% long-term, 40% short-term, no matter
how long you hold it. Like that's just one of
those weird little things. You could hold it for two weeks and you'd still have some long-term gain. Dividends, qualified dividends
for American companies, they're treated as
long-term capital gains. They're treated at those
rates, and so you start seeing, hey, wait a second, there's
some pretty good stuff here. If I hold stock for over a
year, if I receive dividends, if I write out of the money-covered calls, those are all tax advantages. It's like a big star,
you're hit with a magic wand being told these are great
tax treatments right there. Now, let's get into the uh-oh stuff. Capital losses offset capital gains. If you have more capital losses
than you have capital gains, you can use $3,000 a year
against your ordinary income and any that you are not able to use, you just carry forward into future years. So example, I make $10,000 selling stocks, but I have a big loser
that costs me $20,000. So I have $10,000 of
gain, $20,000 of loss. It doesn't matter whether
it's long-term, short-term, that capital gain's gonna go wipe out, or that capital gain is gonna
be wiped out with my losses, whether it's short-term or long-term. So I'll use up $10,000
of my loss, knock out all of my gains so I have zero tax, and now I have an extra
$10,000 of capital losses. I can use 3,000 of that
to offset my other income like W-2 income, business
income, things like that. I can wipe out $3,000. So I'll get to take $3,000 against, let's say I have a job in my W-2 income. So I'd wipe it out and
I'd carry $7,000 forward. So I had 20,000 of loss,
10,000 in gains, wipe that out, now I'm to 10, I take three,
apply it to my other income, and I'm now left over with seven that I carry into the following year. Let's assume that I had $7,000 of gain in the following year. I'd use the entire $7,000 of loss and I'd pay zero tax on any of that gain. That's how the losses work,
but you have to understand that you can't just take capital losses and use them against anything. You have to use them
against capital gains first and then other sources of income. I know that this stuff, some
of you guys are gonna go back and watch this a couple more times. Get a pen out and just
kind of write it down and it'll start making sense. Trust me, there's people that have been doing this for decades. They get it. It's just become second nature
once you start doing it, but the first time you hear
it, the first few times, sometimes it's a little bit muddy, but then you start realizing,
wait a second, the question that most people ask is it
it long-term or short-term? If I get called out, is
it gonna have an adverse tax consequence to me? If I'm selling covered
calls, not a bad thing, I could actually roll
out of a covered call. The time that the stock becomes or the option becomes taxable
is not when I write it, not when I buy it, but when it expires. So either it expires or I
sell it and buy it back, one of those, or it gets assigned. It's when it's closed out is that's when the taxable event
is, just like with stocks. I buy $100,000 of stock,
that's not a taxable event. I buy a bunch of Microsoft,
not a taxable event. When I sell Microsoft, taxable
event and it's gonna depend on how much I paid for it as my basis. You'll also see that your
basis will get adjusted. If I'm selling, for
example, if I sell a call or I buy a call, that's
even a better example, let's say that you're on the
other side of the transaction I talked about earlier
where you have a $10 stock that somebody paid, you
sell that $11 option, and it goes up to $13, right? So I'm the new buyer,
so I bought it at $11, even though it's $13, but
I paid $1 for that option, that dollar plus the stock price, what I paid, becomes my basis. I now, so in the real world,
I bought an option for $1 for the right to buy the company at $11. When I exercise that
option and I buy it at $11, even though it's worth
13, I bought it at 11 but I add the dollar I paid to my basis. So my basis is now $12. So if I sold that stock the next day, so let's say I bought it,
I paid $11 plus the dollar of premium and I sell it the following day for $13 just 'cause I
decided I want to exit out. I have held it for less than
a year, my basis is $12, so my total taxable gain
is 13 minus 12 is $1 of short-term capital gains. That's how that works. It's not horribly complicated, but it is something you'd want to know. Brokerage houses will track
that for you nowadays. There's a few little rules
you need to be worried about, but we can discuss that at a later time, but this gives you a really
good basic understanding of how stocks and options are taxed. (upbeat music)