Capital Gains Taxes (Schedule D on 1040, Form 1099-B, Form 8949)
If the reporting of the gains or losses is needed on the income tax return, it is important to know all about the process.
With your business up and running, being an owner, you might already have the plan to provide equity compensation to the employees of your company. But for that, you as well as your employees need to know all about the capital gains or losses along with the taxes on them. In case an employee purchases a stock and then sells it, they would have to report the capital gains or losses.
If the reporting of the gains or losses is needed on the income tax return, it is important to know all about the process and the changes that the IRS made some years ago. In short, you no longer need to add all the amounts on Schedule D, but would need to add details on the form 8949.
It has been common for many people to use the Schedule D for reporting the capital gains and losses for the trade or sale of specific property in a year. But since 2011, the IRS made a new form called the form 8949 which has to be filed by some of the taxpayers along with the 1040 form and the Schedule D form as well. This article would help you understand all about these forms and how to report the capital gains and losses.
What are capital gains? How is it different from normal income?
The moment you sell off anything you own, which is classified as your capital asset, you either make a capital gain or loss on the transaction. And the IRS needs you to report the amount from any of these capital gains you make, so that you pay the applicable tax on it. On the other hand, you also need to add the capital losses for any possible tax deductions.
It is important to understand that you cannot claim all the capital losses. For instance, you cannot claim a capital loss on the sale of your personal residence as a loss. However, if you lose money by selling stocks of your business or otherwise, you would be able to claim the capital loss.
There are two varieties in the capital losses and capital gains, and they are – long-term and short-term. Here, long-term means the thing that you owned for more than a year, and short-term is something that you owned less than a year.
Tax brackets on short-term & long-term capital gains
The IRS places tax on each and every kind of income, but at different rates. So, the capital gains which includes the sale of a stock, is mostly taxed at a much higher rate as compared to the income tax on the wages or salary. But this does not mean that all the capital gains have the same tax rate.
Other than this, receiving capital gains in a retirement account like an IRA, or a 401(k) plan, also has the power to affect the tax rate. Let us understand both the short-term and long-term capital gains and losses in details as shared below.
Short-term gains and losses
The very first part of the Schedule D would be used to report all the short term gains and losses. And if you hold any asset for a year or less before selling it, is considered as a short-term gain or loss by the IRS.
For instance, if you buy 100 shares of a company on 1st April and then sell them on the 10th of September of the same year, you would have to report the amount it has been sold for on the Form 8949 and the Schedule D as short-term. The moment the short-term capital gains exceeds the losses, you would need to pay the tax on the total capital gains at the standard income tax rate.
The short-term gains don’t have any advantage in the tax rates, and are taxes at the same rate as any other standard income. And as per 2017, the normal tax rate ranges from 10% to 39.6%, based on the total taxable income. The clock starts ticking as soon as you buy the asset till the day you sell it, which is also used to decide if it is a short-term gain or long-term gain.
Long-term gains and losses
The assets that has been held for more than a year before it is sold are called long-term capital gains. It is reported in the form 8949 and the Schedule D under the category – long-term. Long-term capital gains are taxed at a much lower rate as compared to the short-term gains.
In short, if you are able to hold the asset for more than a year, you would get the benefit of paying a much lesser income tax due to the low tax rate. As per 2017, the tax rate for the long-term capital gains were 0%, 15% and 20% for most taxpayers. And in case your income tax rate is already lower than 15%, you would be qualified for a 0% long-term capital gains rate. For those who have a higher income tax rate to pay would also have their capital gains rate at 19.6% off their standard income tax rate.
What is Schedule D on 1040, Form 1099-B and Form 8949?
Before we can talk about Schedule D on the various forms, here are some details on the various forms we would be talking about.
- Form 1040 – This form is for the personal income tax returns that is filed with the IRS for the federal government in the USA.
- Form 1099-B – This form is used by the barter exchanges and the brokers and is called the Proceeds from Broker and Barter Exchange Transactions. It is used to list the various losses and capital gains of all barter exchange or broker transactions.
- Form 8949 – This form is used by corporations, partnerships, and individuals to report the IRS for any the capital gains and losses from any investment activity.
But before we move ahead, it is important to know that the IRS introduced a new tax form in 2011 for reporting the mutual funds, bonds, capital gains and losses from stocks, and other similar investments. Due to this, the investment transactions are now reported on the form 8949, which is the form for Sales and Other Dispositions of Capital Assets. Other than this, the IRS has also altered the Form 1099-B and the Schedule D form to accommodate the form 8949.
The Emergency Economic Stabilization Act
During 2008, Congress had passed the Emergency Economic Stabilization Act, which required brokers to report the cost basis of the investment products to the IRS via the form 1099-B and the relevant investors as well. Theoretically, when a broker reports the cost basis and the sales proceeds, it would reduce the burden on individual taxpayers, who have to maintain an exclusive record of the investments they make. The idea was basically to simplify the process.
Schedule D was a part of form 1040, where all the capital gains and losses were reported. Now the IRS has added the Form 8949 for it. It is important to understand that the Schedule D is used for reporting the capital gains and losses, and this form is connected with many other forms that are used to report various information to the IRS. Here is what the Schedule D is used for in combination with other forms:
- To report a capital loss carryover from 2018 to 2019;
- To report capital gain distributions that is not reported directly on Form 1040, line 13 (or any connected distributions of the capital gains that are not reported on the form 1040NR, line 14);
- To report a gain or loss from a trust, estate, S corporation or partnership;
- To report a gain or capital loss from Form 8824, 6781 or 4684;
- To report capital gains from Part I of Form 4797 or Form 6252 or 2439;
- To report specific transactions that you do not have to report on the Form 8949; and
- To find out the overall gain or loss from transactions that are reported on Form 8949.
The Form 8949 is the main form when it comes to capital gains and it has two columns. This form was not a part of the Schedule D in the previous versions. One column is the Column G to report “adjustments to gain or loss” and a Column B to report a “code.” In short, the column B is used for indicating that the transaction has a special treatment.
For instance, it is for the sale of a main home, a small business stock gain, a section 1202 gain, a wash sale, or if the cost basis that was reported by the broker was not correct. The taxpayers then have the opportunity to re-check and edit the cost basis of the particular transaction by declining the amount mentioned by the broker in Column F and making the alterations in the Column G.
Purpose for these 3 different forms
Now that you are aware of what the Schedule D is all about, let us understand all about the other forms that are involved.
It is an obligation of the brokerage firms or brokers to send out the forms 1099-B to the IRS and the investors. In the form, they have to report the sales of the investment products like the mutual funds or the stocks. Previously, the form 1099-B was only used to report the information regarding the sale of the investment, like the date of the sale and the sale proceeds. Other than that, the taxpayers also had to add the purchase price and date when they were reporting the transactions on their returns and Schedule D.
A lot of brokers have already been reporting the loss/gain reports as the additional details along with their annual reports until 2011. After then, the cost basis details were added in the 1099-B, where the brokers add it here in case there is any supplementary information that they have to provide. Additionally, brokers also had to share the following details on the form:
- The cost basis for stocks acquired (started in 2011);
- The mutual stocks and funds in a dividend reinvestment plan acquired (started in 2012); and
- Any investment product ever acquired (started in 2013).
All in all, the IRS had revised this form so that it could become easier for the cost basis reporting. And with this, the Schedule D is now a simple summary of all the capital gains transactions. If you are looking for where the individual investment sales are reported, they are reported on the Form 8949. Keep reading to know about the form.
This form is used to report the individual investment sales. And there are three categories in the investment sales transactions as mentioned below. Sales of:
- Investments assets for which there isn’t any 1099-B received
- Non-covered securities for which there isn’t any cost basis given
- Covered securities for which the cost basis is provided
The form 8949 reflects the categorization where a separate form is needed for each kind of sale transaction. In each form, you would have to tick the appropriate box at the top of the form. The boxes are:
- Box A – reports the capital gains and losses where the cost basis is offered.
- Box B – reports the capital gains and losses where cost basis in not provided.
- Box C – reports the capital gains and losses where the Form 1099-B wasn’t received.
Moreover, the form also has two pages where the short-term transactions are listed on the first page and the long-term capital gains transactions are listed on the second page. Hence, it is possible that one taxpayer can have more than one form 8949 up to 3 forms. The overall net total from all the forms 8949 are then reported on the Schedule D. The Schedule D has the same structure as the form 8949. You would find out in details about it in the next sections.
The form 1040 is used by people earning in the US for filing their annual income tax return. This forms has a lot of sections, but Schedule D is used for reporting the capital gains and losses. Here are the things for which Schedule D (Form 1040) is used for:
- Nonbusiness bad debts.
- Capital gain distributions that have not been reported directly on the form 1040 (or any connected distributions of the capital gains that are not reported on the form 1040NR).
- Gains from involuntary conversions of capital assets not held for profit or business (other than from theft or casualty).
- The exchange or sale of a capital asset that has not been reported on any other form or schedule.
How to file these forms?
Now let us understand how the reporting is done on the individual forms as shared below.
Reporting Capital Gains & Losses on Form 8949 & 1099-B
The information that you need to report on the Form 8949 is not complex, but planning on which page you would add the details makes it complicated. Prior to filling the forms, create a list of all the capital gains and losses that you have had and then figure out if you have the 1099-B form for all the transactions. The next thing you need to do is divide the transactions separately into 6 groups and categorize them as per the sale transaction.
If you do not have the Form 8949 for the transactions, you would need to fill the 1099-B forms for each type of sale transaction. Here is what you would have to fill in the form 1099-B:
- Short-term transactions that do not have the 1099-B form.
- Short-term transactions that are reported on a 1099-B, but where the cost basis wasn’t reported to the IRS.
- Short-term transactions that are reported on a 1099-B, and also where the cost basis was reported to the IRS.
- Long-term transactions that do not have the form 1099-B.
- Long-term transactions that are reported on the form 1099-B, where the cost basis wasn’t reported to the IRS.
- Long-term transactions that are reported on the form 1099-B, where the cost basis was reported to the IRS.
In case the cost basis of each transaction has already been reported on the form 1099-B, and there isn’t any need to record a code or adjustment for the transactions, you do not have to file the form 8949. In this case, the aggregate of all the transactions can be reported directly on the Schedule D.
Just remember that if you need to file the form 8949, and the transactions you have are of two or three different sales category, you would need to file two different 8949 forms by filling them accordingly. Moreover, if you get three 1099-B forms for three transactions, and one of them does not have the cost basis reported to the IRS, you would have to report one separately where the cost basis was not reported.
In case you have a lot of capital gains and losses that you need to report, you might end up filling several forms. Due to this, it is advised to always organize everything before you begin the filing process.
Information You Need for Each Transaction
The moment you have sorted every transaction, you can move ahead to fill the forms. For each transaction you would need the following details:
- Cost or Other Basis. The cost basis is the total amount paid for the asset along with any other commission or fees. In case you got the asset as a gift, the basis would be amount that the last owner has paid for the asset when they bought it. In case you got the asset as an inheritance, the basis would be the same value as the on the day when the last owner passed away.
- Sales Price. The sale price is the amount which you sold the asset for. In case your broker has already reported the amount on the 1099-B form with all the extra fees and commissions subtracted, report the price.
- Date Sold. The date on which the asset was sold.
- Date Acquired. The date on which you were given or bought the asset in question.
In case the sale or purchase was not a simple, you would have to give the transaction a mark of a specific code. There are a lot of the transactions would also not need any code.
As soon as you have completed the form 8949, you would have to complete the Schedule D by adding all the details to get the net capital gains and losses for each group. This would help you find out the totals from the long-term transactions and short-term transactions that would help you to eventually adjust the income accordingly.
Schedule D (Form 1040)
As soon as you have calculated the total losses and capital gains from the form 8949, you have to move all the details to the Schedule D. The Schedule D would help you figure out the ultimate gain and loss after you have added or subtracted the different elements.
For instance, in case have a carry-over gain from the last tax year, you would add it in the Schedule D for adjusting the form 8949 total capital gains and losses. You would also have to add any of the capital gains distributions that you might have got. Moreover, you would need to follow all the instructions provided on the Schedule D so that you can easily apply the suitable tax rate to the capital gains. This would allow you to put up the right amount on the form 1040 at the end.
Form 1040 Schedule D
The form 1040 is used to file the personal income tax return and includes a part called the Schedule D that has also been explained above. To file this form, you would need to download the form from the IRS website online. Other than that, you can visit the office and get the form 1040 from the officials as well.
As soon as you get the form, fill it as per your details and when you reach the Schedule D part, fill it as per the details shared above as well the Schedule D details shared on the form.
Determining the taxes on your gains
All the details regarding the short-term capital gains would be added in the personal income tax return, and this means that you would have to pay the taxes on it just as you pay for your normal income. As per 2018, the federal income tax rates fall between the range of 10% and 37%. On the other hand, the long-term capital gains get the benefit of a low tax rate, where the lowest possible rate can be 0% and does not exceed 20%.
The losses could be used for reducing the capital gains. In case you have a lot of capital losses, you would be able to drop your income by $3,000 per year, the maximum allowed capital loss in a year. Moreover, in case you do not add the 1099-B information while you file the taxes, you would have to give an answer to the government since the financial services firm always sends a copy directly to the IRS. With these rules made clear, let us understand how to determine long term capital gains tax.
How to Figure Long-Term Capital Gains Tax
It has to be kept in mind that the capital gains in this case is based on the assets that are held for more than a year. In case you realize a profit on assets that were held for less than a year, they are considered as short-term capital gains and are taxed as ordinary income. However, the capital gains on a few sales like the collectibles, and rental real estate sales, are taxed at different rates.
Here are the steps that you need to follow to determine the capital gains:
- Figure out your cost basis. The cost basis is normally the price of the item during purchase along with any added fees or commission. The basis might even be raised by the reinvested dividends on shares and other factors.
- Figure out your realized amount. The amount here is the price for which the asset was sold along with any added fees or commissions.
- After that, get the difference of the basis and realized amount to get the value.
- If you incur a capital loss, You can use the loss to offset any of the capital gains.
- Using a tax rate list, you would be able to determine the long-term capital gains tax rate.
The long-term capital gains have the federal tax rate depending on the category in which the income falls in relation to three cut-off points. The 2018 tax rates are shared below:
- 20% in case your income is over $500,000, and you are a single filing the tax returns. For the married couples filing jointly, it is 20% if the total income is above $600,000.
- 15% in case your income is between $38,701 and $500,000, and you are a single filing the tax returns. For the married couples filing jointly, it is 15% if the total income is between $77,401 and $600,000.
- 0% in case your income is below $38,700, and you are a single filing the tax returns. For the married couples filing jointly, it is 0% if the total income is below $77,400.
Now that you are aware of the capital gains and how to determine it, you would be able to file your tax returns properly if you have bought a stock or if you have just sold the stock and have earned some capital gains. Just remember that in many cases, you would be using the sale and purchase details to finish the form 8949. This is so that you would be able to report the capital gains and losses on Schedule D.
With all these details, it is better to be prepared and file the forms on time, so that you do not end up in any trouble with the IRS or have penalties placed on you. And if you want to know more about the other forms that have not been mentioned here regarding the taxes on the equity compensation, check out the next article.