Tax implications for investors riding the Reddit-fueled stock surges

Yahoo News

Uncle Sam is watching your wins — and losses — from the Reddit-fueled surge in GameStop (GME), AMC (AMC), and other stocks.

If you made a big profit, get ready to pay up to a third of your gains to the tax man. You may also pay higher income taxes, and potentially face a penalty if you won too much without sending a check to the Internal Revenue Service.

If you’re on the wrong side of the stock bet and lost money, take heart: You can deduct some of those losses next year on your taxes.

“Many people … never have to think about the complication of taxes,” Mark Rathjen, an accountant at Why Blu Accounting in San Francisco, told Yahoo Money. “It may be a new experience for them to realize that these are taxable events that they’re incurring.”

If you made a profit

If you played day-trader and made a profit out of the surge, those gains are likely from selling assets you owned for less than a year. Those are short-term capital gains and are taxed differently — and often higher — than long-term capital gains from stocks you held for more than a year.

Long-term capital gains are taxed between zero to 20% — depending on your income bracket — but the average rate is 15%. Short-term capital gains are taxed as ordinary income, meaning the rate could be from 10% to 37%, depending on your income tax bracket.

You short-term gains could also mean a higher tax rate on your income if those gains push you into higher tax bracket, both on the federal and state level — if your state has graduated income taxes.

“They don’t realize they’re not going to be necessarily in the same income bracket,” said Lewis Taub, a certified public accountant and New York director of tax services at Berkowitz Pollack Brant Advisors. “They may, in fact, be putting themselves at 35 or 37% [income tax rate].”

Dealing with the losses

Similar to the profits, losses from this wild ride would likely be short-term losses or losses on stocks you held for less than a year.

You can deduct your short-term losses from your ordinary income, but the deduction is limited to up to $3,000 per year. If your net loss is higher than that threshold, you can carry over the remaining losses to future tax years.

The $3,000 deduction can also decrease the amount of taxable income on other capital gains.

“In the optimal world, it’s best to use your short-term losses against your short-term gains,” Taub said. “If you use those losses against long-term gains, which will typically only be taxed at 15%, you’re not being that efficient with the loss.”

You can also later sell an investment that’s underperforming and use it to offset some of the gains you’ve made that year, a strategy called tax-loss harvesting.

‘You’ve made a lot of money, but you haven’t withheld’

If traders have made big profits, there’s also a risk for under-withholding, or not withholding an adequate amount of tax from your income.

“You’ve made a lot of money, but you haven’t withheld,” Rathjen said. “This means at the end of the year, not only will you get a big tax bill, but you could also incur a tax penalty.”

You must pay at least 90% of your tax liability for the current year or 100% of your tax liability from the previous year — whichever amount is smaller — before tax day to avoid the underpayment penalty.

One way to avoid the penalty is to begin filing quarterly tax payments. Paying estimated taxes allows you to pay your taxes as you receive income rather than pay once a year and potentially face an underpayment penalty.

“So on April 15 of 2021, there are two things due,” Taub said, “a 2020 return and also a first-quarter estimate for 2021.”

Denitsa is a writer for Yahoo Finance and Cashay, a new personal finance website. Follow her on Twitter @denitsa_tsekova.

https://money.yahoo.com/tax-implications-for-stock-surges-193626195.html