The stock market had yet another record-breaking year in 2020. While that means many portfolios likely ended up in the black, it could also mean substantial tax bills for investors who sold stocks last year — especially those that weren't tucked inside an individual retirement account, a 401(k) or some other tax-advantaged retirement account.
Investors who sold individual company stocks while the market was up could be liable for capital gains taxes.
"Gains are good. Taxes are bad," said Robert Fragasso, CEO of Fragasso Financial Advisors in Pittsburgh.
Capital gains only occur when a shareholder sells stock and takes a profit. But it's not always up to the individual investor when to pull the trigger and realize a capital gain.
"If you own a mutual fund, the capital gains are realized for you," Fragasso said. "Then you get a 1099 form at the end of the year telling you those gains have been registered for you inside the funds."
After dropping nearly 20% in March as the pandemic first gripped the U.S., the stock market indexes made a powerful comeback and ended the year at all-time record high levels. The Dow Jones Industrial Average gained 7% in 2020 and crossed the 30,000 milestone; the S&P 500 gained 16%; and the Nasdaq had its best year since 2009, with a 44% gain.
Someone who bought Tesla stock in March at its lowest price of $71 and then sold those shares in December at its highest price of $718 would have a capital gain of $647 per share.
While a relatively small segment of American families — 14% — are directly invested in individual stocks, more than half of U.S. households — 52% — have some investment in the stock market. Most of this stock ownership comes in the form of retirement accounts, such as IRAs and 401(k) plans, according to the Pew Research Center in Washington, D.C.
Generally, any profit that an investor makes on the sale of stock is taxable at either 0%, 15% or 20%, depending on that person's taxable income and filing status if the shares were owned for more than a year. Stocks held for less than a year are taxed at the shareholder's ordinary income tax rate.
Also, any dividends received from stocks are usually taxable. Exactly how much depends on how much you make.