The Gamestop Reddit Retail Investor Robinhood Options Trader Frenzy Will Face Taxes After the Gamification of Buying Stocks
Shares of a handful of firms, such as video game retailer, GameStop Corp., the struggling movie theater, AMC Inc. and BlackBerry Ltd. have posted triple-digit gains in recent weeks, part of a frenzy whipped up by individual investors. Here’s what you need to know. According to reporting from the Wall Street Journal, behind the wild swings, many see ordinary retail investors, who are stuck at home during the pandemic, they have been swapping tips and hatching trading strategies on online forums like Reddit’s WallStreetBets (2.7 million members)—often buying things Wall Street has bet against. Many tout their long-shot wagers with the expression “YOLO,” or, “You only live once.” The Wallstreetbets subreddit forum went private temporarily due to hate speech.
These amateur traders target short sellers who are betting the shares will fall due to what they see as the firm’s business challenges. Goldman Sachs Group Inc.’s basket of the 50 stocks with the highest short interest—Wall Street wagers that the shares will fall—was up 25% for the year through Friday. Surging prices in heavily-shorted shares such as GameStop have led to large losses at hedge funds that bet against stocks, prompting an emergency $2.75 billion deal to rescue one such firm.
The New York Times reported that normally on Wall Street, individual investors are often derided as “dumb money,” destined to lose against the highly compensated analysts and traders who buy and sell stocks for a living. But in recent days, individual investors — many of them followers of a popular, juvenile, foul-mouthed Reddit page called Wall Street Bets — have upended that narrative by banding together to put the squeeze on at least two hedge funds that had bet that GameStop’s shares would fall.
Now nearly everyone who makes money must get acquainted with the taxman aka the IRS at some point. According to recent reporting from Bloomberg, since the pandemic started back in March of last year, 8 million people opened new brokerage accounts who began buying and selling stocks on apps such as Robinhood last year, when they were cut off from other pastimes. And many of them are young traders who were dipping their toes into the investing pool for the first time and now the reality is starting to set in about taxes.
(image credit: Amy Lombard for The New York Times)
And as the Bloomberg contributor writes “Now that these investors realize they could be on the hook for taxes, they aren’t outraged (as George Harrison of the Beatles was when he wrote “Taxman”) as much as confused about the rules.”
The article mentions a 19-year-old investor recently received a notification from Robinhood alerting him that it’s almost tax season, who ended 2020 with less than $5,000 in net gains, and is not sure if he owes any taxes on it.
He told Bloomberg, “I read up on it and everything that I saw didn’t lead me to believe that I had to pay, however I was at the grocery store or something so I didn’t dive into it as much as I needed to.” So I think it’s a good time to cover a refresher on 2020 capital gains tax rates and what should you know if you made money on your investments last year?
Short Term Capital Gains Taxes
(Image credit: Bloomberg)
The U.S. tax code penalizes speculative trading by taxing short-term gains at a higher rate than long-term gains. The dividing line is one year: To get the lower, long-term capital gains rate, investors must hold onto a stock for a year and a day. Married couples who earn up to $80,000 pay nothing on long-term capital gains and qualified dividends. Most other middle-class income groups pay 15%, and the top rate for high earners is 23.8%. Short-term gains, meanwhile, are taxed like ordinary income, at a top rate of 37%.
Those who made big short-term gains in the market last year may owe a hefty check to the Internal Revenue Service and, depending on where they live, to their state tax collection agency.
A recent a NYT’s article explains it this:
“Short-term gains — those on shares held for less than a year — don’t get favorable tax treatment, but are taxed as ordinary income. Rates vary by your tax bracket (currently there are seven, depending on your income and filing status), starting at 10 percent and rising as high as 37 percent. There is also an extra 3.8 percent “net investment income tax” that applies to high-earners (individual filers making more than $200,000, and married couples filing jointly making more than $250,000), for a rate of 40.8 percent.”
If you are not a business owner or partner of a firm, then when you get paid from your employer, taxes are usually withheld from their paychecks. Brokerages rarely do the same for gains on stocks and other investments. That can create a headache when taxes are due in April, especially if investors haven’t put enough money aside.
Long Term Capital Gains Taxes
(image credit: Bloomberg)
A New Jersey financial planner and partner at ELA Financial Group, Ryan Marshall told Bloomberg “the biggest misconception most investors have is that they won’t be taxed as long as they don’t withdraw the money.” Which is true for individual retirement accounts, or 401(k)-style plans. But any other investment income — from selling stocks and bonds, from dividends, and gains created by mutual funds — is taxable.
The Covid-19 stay and work home phenomenon, that skyrocketed boom in new brokerage sign-ups last year means individual investors — known as retail traders — now account for a fifth of stock volume in the U.S., according to data from Bloomberg Intelligence. And was not only in the United States. Trading accounts across the globe tripled from 2019, according to a survey by BrokerChooser. In Japan, online firm Rakuten Securities saw a 25% jump in accounts in nine months, while small investors make up almost two-thirds of trading in South Korea. About one in three people in Saudi Arabia has a brokerage account.
Millennial and new investors are turning to Google, tax websites, online communities, family members or CPA professionals for help as the start of the U.S. filing season approaches — on Feb. 12, two weeks later than usual. Some of these newbie traders are saying “that’s a whole other process that I need to learn, quite honestly I have no idea about any of it,” said Mac Coughlin, a 20-year-old business major at Fordham University. He stated that he took a small loss over the whole course of the year so in terms of filing and tax returns he does not really understand the whole process.
For investors with negative returns in 2020, trading losses can be turned into larger refunds from the IRS. For other investors, however, filing season may be costly. And traders with gains who ignore their tax obligations could wind up with even larger bills down the road.
A long Island CPA named Matthew Savello, told Bloomberg that “one of the key things is you have to budget it. Probably most of the new stock trading investors I talked with actually have losses, there’s not many who can actually pull this off successfully. And for the ones who do, budgeting has become quite an issue.”
The trading app called Robinhood, that has fueled a lot of this new investing activity, said that because it’s a self-directed brokerage, it’s not authorized to give tax advice. It recommends that its customers speak with a tax professional for specific questions about tax documents, including how to file.
Filing as an investor can mean collecting a lot more paperwork. There’s the 1099-B form from brokers, the 1099-INT reporting interest income, and the 1099-DIV for dividends. Some firms consolidate all activity onto one form. It might take until mid-February for your 1099-B to arrive, and other specialized forms, like the K-1s generated by partnership investments, take even longer. Those who trade cryptocurrencies or who jumped from platform to platform in 2020 might need to do extra work to compile all the taxable transactions they need to report.
The IRS gets a copy of every 1099. If you don’t report all of the income, the agency will notice and send a letter demanding money. In many cases, the IRS’s computer could end up charging much more than you actually owe — for example, by taxing the entire proceeds of a sale, rather than just your gain.
It’s in your best interest to get ahead of paying your taxes and don’t become delinquent on them. Jordan Kendall, a partner at Marcum LLP, said “many taxpayers don’t realize that if you’re delinquent in tax filings and you owe the government money, they could withhold your passport and stop you from traveling internationally.” he went on to further say “they could make your life difficult.”
The good thing is that if you enter the right forms, tax software can generally figure out how much you owe. But if you’re trading without knowing the tax rules, you can end up with a much bigger tax bill than expected
In addition to lowering taxes by holding onto investments for more than a year, savvy investors can avoid them entirely by generating losses. By selling stocks that have dropped in value, they can offset any gains in their portfolio. It’s something amateur investors are often reluctant to do.
The tricky thing is though for new investors, is having the discipline to actually sell at a loss, Linda P. Erickson, a financial planner at Erickson Advisors in North Carolina stated “they seem to always want to wait until it ‘comes back.”
So as I mentioned in my previous blog about tax saving strategies for investors, losses can not only erase taxes on gains, they can also offset up $3,000 per year in ordinary income. Losses can also be carried over to future years. However, there’s a catch to this strategy, often called “tax-loss harvesting”: If you sell a stock at a loss, and then buy the stock again within 30 days, you can’t claim the loss on your taxes.
The so-called “wash-sale rule,” designed to prevent taxpayers from gaming the system, could pose a problem for novices who spent 2020 trading in and out of the same few stocks. Their investments may have lost value, but they won’t be able to claim a loss on their 1040 form.
For many, the extra tax costs of trading might just mean a smaller refund. Those who made substantial money in 2020, however, may find themselves with unexpectedly large tax bills. The good news is that the IRS allows people to pay taxes by installment with only a little bit of extra paperwork. The bad news is that penalties and interest can apply. Tax planning can be complex if you have any questions feel free to reach out to Huckabee CPA for a free consultation.