How to Pay Less Tax on Stock Market Gains

Understanding Capital Gains and Taxes

When you make a profit from selling an asset, such as stocks or mutual funds, that profit is known as a capital gain. Capital gains are subject to tax, but the amount you pay depends on whether they are short-term or long-term capital gains. Here’s how each is taxed:

Short-Term Capital Gains (STCG): When you sell an asset within 12 months (for listed equity shares and mutual funds) or 24 months (for unlisted equity shares), the gains are considered short-term. These are taxed at 20% (as per Budget 2024).

Long-Term Capital Gains (LTCG): When you hold an asset for more than 12 months (for listed equity shares and mutual funds) or 24 months (for unlisted equity shares), the gains are considered long-term. The tax rate for LTCG is 12.5% (post-Union Budget 2024), up from 10% previously.

It’s important to understand these taxes, but even more important is knowing how to reduce your tax liability legally, which is the focus of this blog.
 

The Current Stock Market Situation

The Indian stock market has experienced significant fluctuations, especially since September 2024. During a correction phase, stock prices have fallen, which has led to capital gains being taxed at potentially higher rates for those who sold assets at a profit. However, there is an opportunity to minimize taxes by applying tax optimization strategies that legally reduce the tax burden on those gains.
 

Tax-Loss Harvesting: A Legal Way to Pay Less Tax

Tax-loss harvesting is a technique that allows you to offset taxable capital gains by realizing capital losses. This strategy works by selling underperforming assets to book a loss, which can then be used to reduce the tax owed on your gains from other profitable investments.

For example:

• If an investor has made a short-term capital gain of ₹50,000 on one stock, but incurs a short-term capital loss of ₹50,000 on another stock, they can use the loss to offset the gain, effectively reducing their taxable capital gains to ₹0. No tax will be due for that year.
• Similarly, long-term capital losses (LTCL) can be used to offset long-term capital gains (LTCG).
   

Short-Term Capital Gains (STCG) vs. Long-Term Capital Gains (LTCG)

Before diving into tax strategies, it’s important to understand the difference between short-term capital gains and long-term capital gains:

Short-Term Capital Gains (STCG):

• Profits made from selling equity shares or units of equity mutual funds held for less than 12 months (for listed assets).
• The STCG tax rate was previously 15%, but in Union Budget 2024, it was increased to 20%.
• Short-term capital losses (STCL) can be set off against both STCG and LTCG.

Long-Term Capital Gains (LTCG):

• Profits made from assets held for more than 12 months (for listed assets).
• The tax rate for LTCG was increased to 12.5% post-Union Budget 2024, from 10% previously.
• LTCG exceeding ₹1.25 lakh in a financial year are taxed.
• LTCG up to ₹1.25 lakh per financial year is exempt from tax.

Tax optimization strategies become critical in these contexts, especially when it comes to capital losses that can be leveraged to offset gains and reduce tax liability.
 

How to Legally Offset Capital Gains Using Losses

Offsetting Short-Term Capital Losses (STCL)
One of the best ways to reduce tax on stock market profits is by utilizing short-term capital losses (STCL) to offset both STCG and LTCG within the same financial year. This allows investors to offset the gains they’ve made and reduce taxable income.

For example:

• If an investor makes a short-term capital gain of ₹30,000 on one stock and incurs a short-term capital loss of ₹50,000 from the sale of another stock, the investor can use the ₹30,000 loss to offset the gain. This will reduce the taxable amount to ₹0.
• The remaining ₹20,000 loss can be carried forward to future years.

This strategy ensures that investors can reduce taxes without incurring a significant tax burden from short-term gains.
 

Offsetting Long-Term Capital Losses (LTCL)

Long-term capital losses (LTCL) can only be offset against long-term capital gains (LTCG). If an investor has insufficient LTCG in the current year, the long-term losses can be carried forward and used to offset future long-term gains.
 

For example:

• If an investor incurs a long-term capital loss of ₹60,000 but has no long-term capital gains in that year, they can carry forward the loss and apply it to any future LTCG.

This gives investors the flexibility to adjust their tax obligations in future years, making it an important tool for long-term tax planning.
 

Short-Term vs. Long-Term Losses: What’s the Difference?

Understanding how short-term and long-term losses can be used to offset gains is crucial. Here’s a comparison:

• Short-term capital losses (STCL) can be used to offset both STCG and LTCG.
• Long-term capital losses (LTCL) can only be used to offset LTCG.

This distinction plays an important role in how investors can optimize their tax efficiency.
 

How to Carry Forward Capital Losses for Future Years

Sometimes, you may not have enough gains to offset your capital losses in the current financial year. Fortunately, the Income Tax Act allows you to carry forward capital losses for up to 8 years. However, there is a condition: you must report these losses in your Income Tax Return (ITR) within the due date to claim the benefit.

For example:

• If an investor incurs a short-term capital loss of ₹50,000 and has only ₹30,000 in gains that year, the remaining ₹20,000 loss can be carried forward. This loss can be set off against future gains in the subsequent years.

Carrying forward losses is an essential component of tax optimization for investors who face losses during market corrections.
 

Example of Paying Less Tax Using Tax-Loss Harvesting

Let’s look at a practical example:

• Investor A buys 100 shares of Company X at ₹200 each, investing a total of ₹20,000.
• After some time, the price of Company X’s stock falls to ₹100, and Investor A decides to sell, realizing a short-term capital loss of ₹10,000.
• Investor A also sells some shares of Company Y, which were bought for ₹12,000 and sold for ₹15,000, realizing a short-term capital gain of ₹3,000.
• By using tax-loss harvesting, Investor A can offset the ₹3,000 gain with the ₹10,000 loss, resulting in no tax for that year. The remaining ₹7,000 loss can be carried forward.

This example illustrates how tax-loss harvesting can help reduce taxable income, thus allowing investors to legally pay less tax on their gains.
 

Risks and Considerations

Although tax-loss harvesting and carrying forward losses are powerful strategies, there are certain risks and considerations to keep in mind:

• Tracking Error: Using a passive investment strategy could lead to tracking errors if gains or losses deviate from the benchmark, resulting in less-than-expected tax savings.
• LTCG Exemption Limit: Long-term capital gains up to ₹1.25 lakh per financial year are exempt from tax. It’s essential to consider this exemption before utilizing LTCL, as losses below this limit will not yield additional tax benefits.
   

Conclusion: Legally Paying Less Tax on Stock Market Gains

Tax planning is a critical aspect of investing, and with the right strategies, investors can legally reduce the tax burden on their stock market gains. By utilizing tax-loss harvesting, offsetting gains with capital losses, and carrying forward losses for future years, investors can ensure that they are not overpaying taxes on their hard-earned profits.

In conclusion, paying less tax legally requires smart tax management and an understanding of the provisions within the Income Tax Act that benefit investors. It is crucial to maintain proper records and file tax returns on time to ensure the efficient use of tax-saving strategies.

Investors should always consult with financial advisors or tax professionals to effectively apply these strategies and ensure they are maximizing their tax benefits while remaining compliant with tax laws. With the right planning, you can legally pay less tax on your stock market gains and keep more of your profits.