Income Tax vs. Capital Gains Tax: What’s the Difference?

Income Tax vs. Capital Gains Tax: An Overview

Income taxes and capital gains taxes are both ways the government collects revenue, but they apply to very different types of income. In general, income taxes are levied on the money you earn through employment or self-employment, while capital gains taxes apply to profits made from selling a capital asset like your home, stocks, and bonds.

While both affect your take-home earnings, the rules, rates, and strategies for minimizing them can vary significantly, and knowing the difference will help you better manage your finances—and potentially lower your tax bill.

Key Takeaways

• Income tax applies to wages, salaries, and other earned income and is taxed at ordinary income rates based on tax brackets.
• The U.S. income tax system is progressive, with rates from 10% to 37%, meaning higher-income earners are taxed at higher rates than lower-income earners.
• A capital gains tax applies to profits from the sale of assets like stocks or property; long-term assets, which are held for more than one year, are generally taxed at a lower rate than short-term assets.

Income Tax

Income tax is applied to most forms of earned income. This includes wages, salaries, tips, commissions, and income from freelance or contract work. It also covers unearned income such as interest and rental income, depending on your situation.

The United States operates on a progressive income tax system, so your income is taxed at increasing rates as it reaches higher brackets. For example, in 2025, the federal income tax brackets range from 10% to 37%, depending on your filing status and total taxable income. Most states also have their own income tax systems, which can be either flat or progressive.

Employers typically withhold income tax from paychecks, and self-employed individuals make estimated tax payments quarterly. Further, taxpayers can reduce their income tax burden through deductions, tax credits, and some types of retirement contributions.

Capital Gains Tax

Capital gains tax is triggered when you sell an investment or asset for more than you paid for it. Common examples include stocks, bonds, mutual funds, real estate, and even household furnishings and collectibles. The tax applies only to the gain—the difference between the selling price and the original purchase price.

Capital gains are considered either short-term or long-term. If you hold the asset for one year or less before selling, it’s considered a short-term capital gain and taxed at ordinary income tax rates. If you hold the asset for more than a year, it’s considered a long-term capital gain and generally taxed at lower rates—0%, 15%, or 20%, depending on your taxable income. Some types of asset sales may trigger a capital gains tax rate that is greater than 20%—for example, net capital gains from selling collectibles are taxed at a maximum 28% rate.

There are also surtaxes, like the 3.8% net investment income tax, that may apply to high earners. And while capital gains taxes are mostly a federal concern, some states tax them as well and sometimes treat them the same as regular income. The following table shows the capital gains tax brackets.

Key Differences

The main difference between income tax and capital gains tax lies in the type of income being taxed and the rates applied. Income tax covers earned income and is subject to a progressive tax structure. Capital gains tax applies to investment profits and can offer lower rates, especially for long-term holdings. It’s also important to note that long-term capital gains do not impact your ordinary income, so you don’t need to worry about this type of sale pushing you into a higher tax bracket.

From a planning standpoint, capital gains taxes often offer you more flexibility. For example, you might choose when to sell an asset to time the gain with a year when you’re in a lower tax bracket. You can also be mindful about holding assets for at least one year before selling for a gain. That kind of timing isn’t available for income taxes, which are based on when the income is earned.

How to Calculate Capital Gains

To calculate a capital gain, you should subtract your cost basis from the selling price of the asset. The cost basis includes what you originally paid for the asset, plus any fees or commissions related to the purchase.

Capital Gain = Sale Price – Cost Basis

If the result is positive, you’re dealing with a capital gain. If it’s negative, you’ve incurred a capital loss, which can be used to offset other gains or even reduce your taxable income (up to $3,000 per year, as allowed by the Internal Revenue Service).

For assets held longer than one year, you’ll need to apply the long-term capital gains. And remember: If you sell within one year, your gain is taxed at your ordinary income tax rate, which can be substantially higher.

Income Tax vs. Capital Gains Tax Example

Let’s say you earn $80,000 in salary in a given year. That income is subject to federal income tax, possibly in the 22% bracket depending on your filing status. You’ll pay income tax through paycheck withholding, and possibly owe more or get a refund when you file your tax return.

Now, imagine you also sold stock for a $10,000 profit. If you held the stock for more than a year, the gain qualifies for long-term capital gains treatment. At your income level, you’d likely pay 15% in federal taxes on that gain, or $1,500 (assuming you’re filing single). If, instead, you sold the stock after holding it for just six months, the gain would be taxed as ordinary income—so, potentially at the same 22% rate as your salary.

The Bottom Line

Income taxes and capital gains taxes both affect your personal finances, but they apply to different activities and warrant different tax considerations. While income tax is largely unavoidable and based on what you earn, capital gains tax can often be managed more proactively; for example, by holding an asset for more than a year, you’ll likely pay far less in taxes than if you sold for a gain within a month.

By understanding how each works—and how they interact—you can make more informed decisions about your income, investments, and tax planning. When in doubt, working with a tax advisor can help you chart the most effective path forward.