Stock trading on a prop firm can be a powerful way to build wealth and grow a funded account, but it also comes with tax responsibilities.
If you’re trading full-time or just investing on the side, understanding how capital gains, dividends, and losses are taxed is crucial for managing your earnings effectively and keeping hold of as much profit as possible.
Taxes on stock trading vary based on holding periods, profit types, and reinvestment strategies. This guide from the Falcon Funded team breaks down the key tax terms and how they impact traders.
Key Tax Terms Every Trader Should Know
Understanding tax terms is essential for managing trading profits efficiently. Here are the main core terms you’ll need to know to master your trading.
Dividend
A dividend is a payment made to shareholders from a company’s profits. These payments are typically distributed annually or quarterly based on the number of shares owned.
- Qualified dividends are taxed at the capital gains tax rate (0%, 15%, or 20%).
- Ordinary dividends (non-qualified) are taxed at regular income tax rates.
Cost Basis
The cost basis represents the original purchase price of a stock, including broker commissions and other transaction fees. This value is essential for calculating capital gains or losses when selling assets.
Capital Gains & Losses
Capital gain refers to the profit made when selling a stock for more than its purchase price. Conversely, capital loss is a deficit incurred when selling a stock for less than its purchase price.
Understanding these definitions is key to knowing how your trading profits are taxed. As well as having a strong risk management strategy, getting your head around proper trading terms is essential before you start trading properly.
Check out our A-Z Trading Glossary for more key terms you need to know.
Tax Implications for Trading Dividends
If a trader has stocks or assets that pay dividends, that money is often taxable. The tax rates on dividends will vary depending on whether they are qualified or not.
A qualified dividend is taxed at a capital gains tax rate. In contrast, a non-qualified dividend (sometimes called an ordinary dividend) is taxed at the regular income rate of the person receiving the dividend. The tax rate of qualified dividends will vary depending on the tax bracket of whoever gets the dividend, but it will be 0%, 15% or 20%.
Reinvesting dividends through a dividend reinvestment plan (DRIP) also incurs a tax. In this case, the dividend is taxed at its cash value. If the DRIP allows investors to purchase more shares at a discounted price, the investor is then taxed the difference between the reinvested money and the stock’s fair market value.
If a received dividend is in the form of stock, these are usually not taxed until sold. When selling stocks, the buyer is not taxed, but the seller will be taxed.
How Much Tax Do You Pay on Stock Gains and Losses?
The amount of tax owed on stock trading profits depends on how long the asset was held before being sold.
Short-term capital gains apply to stocks that were held for one year or less before selling. These gains are taxed at the trader’s ordinary income tax rate, which can be significantly higher depending on income level.
On the other hand, long-term capital gains apply to stocks that were held for more than one year before selling. These gains benefit from lower tax rates, typically 0%, 15%, or 20%, depending on taxable income.
For traders who sell stocks at a loss, there are potential tax deductions available. Up to $3,000 in capital losses can be used to offset either capital gains or regular income each year. If losses exceed this limit, the remaining amount can be carried forward to future tax years, reducing taxable income in later periods. This makes strategic loss management an important part of tax planning for active traders.
However, it’s important to be aware of the wash sale rule, which prevents traders from claiming tax deductions on losses if they repurchase the same stock (or a substantially identical one) within 30 days before or after selling at a loss. The IRS does not allow such losses to be deducted, meaning traders need to carefully time their trades to avoid disqualification for tax benefits.
Final Thoughts
Stock trading comes with tax implications, but knowing how gains, losses, and dividends are taxed helps traders make informed decisions… And minimize those implications over time.
Ready to get started on your trading journey? Falcon Funded provides traders with access to capital, allowing them to scale their trading careers while keeping earnings in check.
With biweekly payouts and a transparent profit-sharing model, Falcon Funded makes sure that traders get paid efficiently and plan for tax obligations accordingly. Get started with Falcon Funded today to get the most out of your trades without putting your own money on the line.
