How does the tax treatment differ between short-term and long-term capital gains?

The correct answer highlights a significant distinction in how short-term and long-term capital gains are treated under tax law. Short-term capital gains, which arise from the sale of assets held for one year or less, are taxed as ordinary income. This means they are subject to the same tax rates as your other income, such as salary or wages, which can be higher depending on your overall tax bracket.

In contrast, long-term capital gains, resulting from the sale of assets held for more than one year, are taxed at preferential rates. These rates are generally lower than ordinary income rates, reflecting a policy aimed at encouraging long-term investment. This differential treatment is designed to promote stability in the financial markets by incentivizing taxpayers to hold investments for longer periods.

The distinctions in tax treatment serve to influence taxpayer behavior in investment strategies, encouraging longer-term holding of assets, which can contribute to overall market health. Understanding this difference is crucial for effective tax planning and investment decisions.