What is Zakat?
I'm guessing you already know (since you likely looked up this article by searching for it), but let's throw a definition in for completeness. Zakat refers to the obligation a Muslim has to donate a certain proportion of their wealth each year to charitable causes. As one of the Five Pillars of Islam, Zakat is mandatory for all Muslims who meet the necessary criteria of wealth.
The purpose of Zakat is to purify a person's wealth and earnings by giving a portion of it to those in need. This is purification from stinginess, greed and lack of empathy towards the needy.
Who's required to pay Zakat?
The minimum amount of wealth that a person must have before they are required to pay Zakat is called nisab. The amount of the nisab is 85 grams (2.73295 troy ounces) of 24k gold, or the equivalent in your local currency.
The price of gold was $1,864.2 per troy oz on 6 Jan 2023, so the nisab would be 2.73295 troy ounces * $1,864.2 = $5,094.77.
The wealth on which zakat should be paid must have been held for at least one full year (or the hawl) in order to become eligible for Zakat.
In summary, any person who's owned more than $5,094.77 over the past lunar year must pay Zakat on the excess wealth above $5,094.77, at the rate of 2.5% of the excess amount of cash.
Zakat On Cash
Zakat on any cash balance that you hold, regardless of whether you keep that balance at a broker, in a bank account or under your pillow is 2.5%. This rate only applies to money you've had for over a year.
This bit is pretty straight forward, and it's what all scholars agree on.
Zakat on Stocks
Zakat on stocks is a different matter; there are several opinions on how stocks get treated, the rate that applies, as well as the portion of the portfolio you're required to pay Zakat on.
Active (Short-term) Positions
If your intention, at the time of investment, was to trade in the stocks (for a short term profile), then they're basically treated like cash, and you pay 2.5% on the stocks you own.
Passive (Long-term) Positions
Opinions about the Zakat due on positions where the intention is to hold them for more than a year, differ. There are two popular ones:
International Islamic Fiqh Academy
The math can be tricky to grapple with, but the theory is simple:
You own shares in companies. These companies own assets. They should pay the 2.5% zakat rate on these assets. But since the companies don't, you should pay your share.
All companies are required to report on "Current Assets", so that's what you'd use as a reference. Your portion of this is the numer of shares you own divided by the total outstanding shares. You'd then just pay the 2.5% zakat on the result.
Some scholars have approved the use of taking 30% of the current market value of a stock or fund as an approximation for current assets when this information is not readily available. This can be helpful for individuals who are unsure of the exact current assets of a business, but still want to ensure that they are accurately calculating their Zakat obligations.
Fiqh Council of North America
The Fiqh Council of North America laid out their rationale for calculating Zakat:
Muslim scholars believe stocks and investments are most appropriately categorized as "the produce of plowed land," as both are "productive capital" assets which yield gains. Accordingly, zakat is due on the gains of such "productive capital," not the "productive capital" itself.
The Prophet (Salla Allahu Alayhi wa Sallam) said: "On a land irrigated by rain water or by natural water channels or if the land is wet due to a nearby water channel, ushr (i.e. one-tenth, 10%) is compulsory (as zakat); and on the land irrigated by the well, half of ushr (i.e. one twentieth, 5%) is compulsory (as zakat on the yield of the land)."
This is the basis for their calculation: 10% of the gains in stocks over the course of a given year. More specifically, they calculate it like so:
Also, it's worth clarifying that if you don't make any money on a given year, you don't pay Zakat — since the 10% rate applies only to the gain in your portfolio.
In conclusion, the Zakat treatment of stocks can vary depending on the type of stock holdings an individual has. By following the guidelines outlined above, individuals can ensure that they are accurately calculating and paying their Zakat obligations on their stock holdings.