Equity is taxed in three main ways: as capital gains when you sell shares, as dividends while you hold them, and as ordinary compensation when an employer grants you stock or options that vest or get exercised. Federal capital gains rates run from 0% to 23.8% depending on income and holding period, dividends split into qualified (taxed at capital gains rates) and ordinary (taxed as regular income), and employee equity gets pulled onto your W-2 at specific triggering events. The rules interlock, and the biggest tax mistakes come from missing how one category feeds another.
Tax on Selling Stock
Selling shares at a profit produces a capital gain, and the rate you pay depends almost entirely on one thing: how long you owned the shares before selling.
Hold shares for one year or less, and any profit is a short-term capital gain, taxed at your ordinary income rate. For 2026, those rates run from 10% to 37%.1Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 Hold for more than a year, and the profit is a long-term capital gain, taxed at 0%, 15%, or 20% based on your taxable income.2Internal Revenue Service. Topic No. 409, Capital Gains and Losses For 2026, single filers stay in the 0% bracket up to $49,450 of taxable income, and married joint filers up to $98,900. The 20% rate kicks in above $545,500 for singles and $613,700 for joint filers.3Internal Revenue Service. Revenue Procedure 2025-32
Higher earners face an additional layer. The Net Investment Income Tax adds 3.8% on top of your capital gains rate once modified adjusted gross income exceeds $200,000 for single filers or $250,000 for married joint filers.4Internal Revenue Service. Net Investment Income Tax Those thresholds are not indexed for inflation. The top combined federal rate on a long-term gain reaches 23.8%, compared to as much as 37% on a short-term sale. If you’re close to the one-year mark on a position you want to sell, that gap is worth waiting out.
Tax on Dividends
Dividends come in two categories, and the difference can double your tax bill on the same payment.
Qualified dividends are taxed at the same 0%, 15%, or 20% rates as long-term capital gains. To qualify, a dividend must come from a U.S. corporation or eligible foreign corporation, and you must have held the stock more than 60 days during the 121-day window around the ex-dividend date.5Cornell Law Institute. 26 USC 1(h)(11) – Definition of Qualified Dividend Income Buy shares right before the dividend, collect it, then sell, and the payment gets taxed as ordinary income because you didn’t hold long enough.
Ordinary dividends land on your return as regular income at rates up to 37%.6Internal Revenue Service. Topic No. 404, Dividends and Other Corporate Distributions Your brokerage separates the two on the year-end 1099-DIV, so the holding-period math is usually done for you. Receive more than $1,500 in ordinary dividends, and you also need to file Schedule B.
Tax on Employee Equity Awards
Equity given to you as compensation is taxed differently from stock you buy on the open market. The type of award decides when tax hits and at what rate.
Restricted Stock Units
RSUs are taxed as ordinary income the moment they vest. Your employer reports the fair market value of the vesting shares on your W-2 and withholds federal and payroll taxes, often by selling a portion of the shares automatically.7Internal Revenue Service. Publication 525, Taxable and Nontaxable Income After that, any change in value counts as a capital gain or loss when you eventually sell, using the vesting-date price as your cost basis.
Non-Qualified Stock Options
Non-qualified options (NQSOs) trigger tax at exercise, not at grant. The spread between your exercise price and the market price on the day you exercise is treated as ordinary income and shows up on your W-2.8Internal Revenue Service. Topic No. 427, Stock Options If you keep the shares after exercising, further gains are taxed as capital gains when you sell.
Incentive Stock Options
ISOs get the friendliest treatment on paper. Exercising an ISO creates no regular income tax event, and if you hold the shares at least two years from the grant date and one year from the exercise date, the entire profit is taxed as a long-term capital gain.8Internal Revenue Service. Topic No. 427, Stock Options The catch is the Alternative Minimum Tax. The exercise spread counts as income for AMT purposes even though it doesn’t for regular tax, and a large ISO exercise on appreciated stock can trigger a substantial AMT bill in the year of exercise.1Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 Run the AMT numbers before you exercise a large grant.
Section 83(b) Election
If you receive actual restricted stock (not RSUs) subject to a vesting schedule, a Section 83(b) election lets you pay ordinary income tax on the value at grant rather than at vesting. It’s a bet on the price rising: pay tax now on a lower number, convert the future appreciation into capital gain. The election must be filed within 30 days of receiving the shares, with no extensions available.9Internal Revenue Service. Form 15620 Instructions for Section 83(b) Election Miss that window and you’re taxed on the vesting-date value, whatever it turns out to be.
The Cost Basis Trap With Employee Equity
The single most expensive mistake with employee stock is double-taxation from a wrong cost basis. When RSUs vest or you exercise NQSOs, the compensation income goes on your W-2 and taxes are withheld. Some brokerages then report the cost basis on Form 1099-B as $0, or as the original grant price, rather than the fair market value that was already taxed as wages. If you accept that number, you’ll pay capital gains tax on income you already paid ordinary income tax on.
The correction is done on Form 8949 by adjusting the reported basis up to the amount already taxed as compensation.7Internal Revenue Service. Publication 525, Taxable and Nontaxable Income Compare your 1099-B against your W-2 supplemental statements every year you sell employer stock.
Using Losses to Offset Gains
Capital losses offset capital gains dollar for dollar. If total losses exceed total gains, you can deduct up to $3,000 of the excess against ordinary income each year ($1,500 if married filing separately), and any remainder carries forward indefinitely, keeping its short-term or long-term character.2Internal Revenue Service. Topic No. 409, Capital Gains and Losses10Office of the Law Revision Counsel. 26 USC 1212 – Capital Loss Carrybacks and Carryovers
The wash sale rule limits this. Sell shares at a loss and buy substantially identical securities within 30 days before or after the sale, and the loss is disallowed for the current year.11Internal Revenue Service. IRS VITA Courseware – Wash Sales The disallowed loss isn’t lost; it’s added to the basis of the replacement shares, so the tax benefit is only deferred until you sell those in a clean transaction. Brokerages flag wash sales on Form 1099-B, but they only see one account. If you hold the same stock in multiple accounts (including an IRA), track this yourself.
If a stock becomes completely worthless, you can claim the loss as if the shares were sold for $0 on the last day of the tax year, reported on Form 8949.12Internal Revenue Service. Losses – Homes, Stocks, Other Property
Inherited Stock Gets a Stepped-Up Basis
Inherited shares don’t carry the deceased owner’s original cost basis. Instead, your basis is the fair market value of the stock on the date of death.13Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent If a parent bought shares for $10,000 that were worth $200,000 at death, and you sell for $205,000, you owe tax on $5,000 of gain, not $195,000.14Internal Revenue Service. Gifts and Inheritances Get the date-of-death value from the executor before you sell or report anything.
Inherited stock is also always treated as long-term when you sell, regardless of how briefly you held it after inheriting.
Reporting and Paying What You Owe
Every stock sale during the year goes on Form 8949, sorted into short-term and long-term and grouped by whether the broker reported basis to the IRS.15Internal Revenue Service. Instructions for Form 8949 Totals flow to Schedule D, which computes your net capital gain or loss on Form 1040.16Internal Revenue Service. Form 8949 Tax software imports the 1099-B and does the mapping, but review the imported basis on any employee equity sales before filing.
If a big sale will leave you owing $1,000 or more in tax above what payroll withholding covers, you may need quarterly estimated payments to avoid an underpayment penalty. The 2026 due dates are April 15, June 15, September 15, and January 15, 2027.17Internal Revenue Service. 2026 Form 1040-ES, Estimated Tax for Individuals You avoid the penalty by paying at least 90% of the current year’s tax or 100% of the prior year’s tax, whichever is less; that 100% figure rises to 110% if prior-year AGI exceeded $150,000.18Internal Revenue Service. Underpayment of Estimated Tax by Individuals Penalty
Skip a sale on your return and the IRS matching system will find it, because your brokerage already sent the 1099-B. A substantial understatement carries a 20% accuracy-related penalty on the underpaid tax, rising to 40% for gross valuation misstatements, plus interest from the original due date.19Office of the Law Revision Counsel. 26 USC 6662 – Imposition of Accuracy-Related Penalty on Underpayments
State Tax Adds Another Layer
Federal rates are only part of the bill. Most states tax capital gains as ordinary income, with rates ranging from 0% in states with no income tax to above 13% in the highest-tax states. A few states offer partial exclusions or preferential rates for long-term gains, but most just fold the gain into state taxable income. Before you sell a large position, add your state rate to the federal rate to see the real number.