complete newbie to brokerage account - tax question
April 28, 2021 8:05 PM   Subscribe

A generous relative is helping me (someone with zero experience/knowledge of investment) set up a brokerage account (not a retirement account, which I know is different) and is going to start off by depositing some money for me to do what I wish with. I'll be seeking detailed investment advice elsewhere, but for the purposes of this post, I have tax questions.

I realize that any interest I earn from investments is taxable. But my questions are:

1. Do I pay the taxes on this interest every year no matter what, or only when I withdraw/use/transfer it?
2. Will I need to pay taxes on the initial amount given to me by the relative who sets up the account? I think it's going to be more than the annual gift allowance of $15k.
3. When I start adding money (transferred from my regular checking/savings) to the new account myself, does that count as taxable income or something else?

Sorry if this is obvious! I hope it makes sense.
posted by CancerSucks to Work & Money (11 answers total) 1 user marked this as a favorite
Assuming you're American...

(1) Income received in a regular brokerage account, whether interest, dividends, or other, is taxable. However, if you own, e.g., a stock and the price of the stock goes up that year, you are not taxed on that gain, which is only a paper gain, until you sell that stock and "realize" the gain. You will receive 1099s at the end of the year from your brokerage showing any taxable income you've received.

(2) No. Even if it were taxable, which it is almost certainly not, the giver, not the recipient, pays the taxes.

(3) That money is not taxable income. You're just reallocating your money from one form of asset (e.g., checking account) to another (e.g., a stock). You pay taxes as described in (1). If you buy a stock for $5, funding the purchase from your checking account, and the stock doesn't pay dividends, and you don't sell it all year, you recognize no taxable income.
posted by praemunire at 8:22 PM on April 28 [8 favorites]

There are three different ways you can make money with a brokerage account, all taxable:

1) Cash sitting in the account pays interest. Interest rates are in the dump right now, so even a balance of thousands of dollars will pay pennies per month. But those pennies are taxable income.

2) If you own a stock - or a group of stocks via an ETF or a mutual fund - those stocks will regularly pay dividends. For example, on December 12, 2020, Microsoft announced that anyone holding MSFT stock on February 18, 2021 would be paid a dividend of 56 cents per share on March 11, 2021. Most corporations that pay a dividend - and not all do - make a similar announcement every three months. Dividends are taxable income. Some dividends - based on how long you've held the stock and continue to hold it - are taxed at the long-term capital gains rate. These are theoretically taxable the moment you receive them, but unless you have a 6-figure account balance, you can probably wait until the end of the year and pay the taxes on them when you fill out your tax return.

But, the main way to make money with a brokerage account is...

3) If you've bought stock in the past and are now deciding to sell it, any profit you make on that sale is Capital Gains. Depending on your total income and how long you've held it, capital gains are taxed anywhere between 0 and 40% of the profit. If you had bought ten shares of MSFT a year ago, you would have paid about $1750, and today you could sell that for about $2550, a nice $800 profit - plus those four 56c/share dividends you would have gotten over the past year. The $800 profit is taxable at the time of gain, but again, you can probably hold off paying it until the end of the year. Just be aware that owing more than $1000 to the IRS at the end of the year can open you up to penalties.

Separately, if you take a loss on a stock sale by selling it for less than you paid, that loss can be deducted against other gains, and even up to $3000 of your regular income.

As for moving money into the account, your relative might be liable for gift tax, but you will not be. Moving your own money into the account is not a taxable event.

At the end of the year, the brokerage will send you a 1099 outlining the interest, dividends, and proceeds from sales; you will need to know what you paid for the stock (your 'basis') to calculate your capital gains.
posted by Hatashran at 8:28 PM on April 28 [4 favorites]

FYI each person has a lifetime gift tax tax exemption of $11.58 million. That means that the person can give up to $11.58 million in gifts over his/her lifetime, distributed among any number of people, before any gift tax must be paid.

In addition, there is an annual gift exclusion of $15,000. If you give below that amount to a person, you don't even have to report it to the IRS. If you give more than that, you have to file a certain form with the IRS and the amount above $15,000 is counted towards your lifetime $11.58 million limit.

Also the annual gift exclusion is per person. So just for example, if your relative has a spouse and you have a spouse, relative could give you & spouse both $15,000, and relative's spouse could give you & spouse both $15,000. So that would amount to $60,000 transferred from his family to yours without even triggering the IRS annual gift reporting or touching relative's or relative's spouse's lifetime gift limit.

In short: Gift tax filings and taxes are all on the giver, and at most the giver will just have to file an extra form with their annual taxes which will result in no extra tax due at all. Unless relative is giving away literally millions and millions.

This article breaks down the issue pretty well. This IRS page answers some frequently asked questions.
posted by flug at 12:16 AM on April 29 [3 favorites]

By the way, the brokerage will send you (or post on a website) a year-end tax form called a 1099-DIV or 1099-INT or something similar. This will have all the info you need to do your taxes. So, you don't need to worry about trying to keep track of taxable things that happen - it is all set out in the form.
posted by Mid at 6:25 AM on April 29 [3 favorites]

RE: basic taxability for a taxable brokerage account:

At the end of the year you will get a 1099 form that tells how much interest or dividends you received that you have to pay. If you have a taxable account, then you will pay some tax on this. I have 6 figures in a taxable Vanguard account, and receive around $2k a year in dividends. They send me a 1099-DIV form and I pay some minor amount of tax on (less than $100 I think).

You didn't really ask this, but depending on your income, you can set up accounts that don't pay tax until you sell the capital gains of the stock, and if you don't sell anything, you don't pay any yearly taxes.
posted by The_Vegetables at 7:45 AM on April 29

Also brokerage, retirement, etc all all essentially interchangeable currently, even if they weren't historically. You can have a brokerage retirement account. The various tax designations (401k, 403b, Roth, regular IRA) are the important part. My taxable one is named by Vanguard "Brokerage" and my Roth IRA through them is a "ROTH brokerage" and my wife's IRA is "Rollover IRA brokerage".
posted by The_Vegetables at 7:49 AM on April 29 [2 favorites]

All of the above is good. One decision you can make now is whether to automatically reinvest dividends. For example, if you own $1000 of a dividend-paying asset (such as a mutual fund or exchange-traded fund (ETF) or stock, and they pay you a $10 dividend, the brokerage can either just put $10 in cash in your account, or take that $10 and buy another $10 worth of that asset.

Reinvesting dividends is a good idea in concept, but it can make the tax computation much more complicated when you eventually sell the asset. As mentioned before, you will probably pay capital gains tax on the difference between what you paid (the "basis") and what you sold it for. But if you reinvest dividends, then you'll have bought perhaps 100 shares in year 1, then 0.8 shares in year 2, and 0.9 shares in year 3, etc. Dividends tend to be pretty small, so for simplicity, you might want to ask the brokerage not to automatically reinvest them. (You can also ask the brokerage if they automatically provide you with the basis; if so, there's less to worry about.)
posted by Mr.Know-it-some at 8:01 AM on April 29 [1 favorite]

Reinvesting dividends is a good idea in concept, but it can make the tax computation much more complicated when you eventually sell the asset.

This means more in theory than it does in real life, in my opinion. I've sold stock with dividends, and the calculations are very straight forward, and there were some extra tax prep fees (that as far as I can tell, are charged by major tax prep companies just because you have a 1099, whether it's a single form with no sales or a long form with some sales).

If you are going to become a day-trader, with tons of trades, then maybe not reinvesting your dividends makes sense. But everyone else should.
posted by The_Vegetables at 9:15 AM on April 29 [1 favorite]

(You can also ask the brokerage if they automatically provide you with the basis; if so, there's less to worry about.)

In the United States, brokerages are required to track your basis for you as of 2012, so all of this stuff will be reflected in your 1099 at the end of the year.

And if you are just dealing with one type of asset, like a total market mutual fund, all you really have to report on your taxes is the net short- and/or long-term gain or loss for that security over the year, rather than the individual transactions. It can be as simple as reporting (from your 1099) one number for capital gain/loss and another number for dividend/interest income.
posted by AndrewInDC at 9:34 AM on April 29 [1 favorite]

What AndrewInDC said. The annoyance remains for those of us who had investments prior to that date, but new investors shouldn't have this problem.
posted by praemunire at 10:11 AM on April 29

Thank you; I wasn't aware of that! My advice still applies if it's 2011 in your time zone.
posted by Mr.Know-it-some at 10:29 AM on April 29 [1 favorite]

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