If you’re among the investors who made money in the recent rally of GameStop, AMC and other high-flying stocks, be prepared to pay the taxman.
You may not be aware you'll be on the hook for paying capital gains taxes on any profits, an issue that seasoned investors are focused on since a tax hit lowers their after-tax rate of return.
But first, it’s important to be aware of when and how you may owe taxes on that GameStop stock — although some investors might end up recording a loss, given Tuesday’s plunge in the game retailer’s stock price.
Investors who sold their stock in early 2021 to lock in their gains will need to pay the capital gains tax in early 2022, when they file their tax returns for the current year. Some investors have made small fortunes in the past month, such as one 19-year-old who told USA TODAY his account had peaked above a “life-changing” $100,000.
But investors who haven’t sold shares, even if they are enjoying paper gains, won’t owe anything — a fact that some younger investors might not realize, experts say.
“We've seen an increase in millennial and Gen Z investors, especially over the past year with what's going on in the volatile stock market,” says Lisa Greene-Lewis, TurboTax CPA and tax expert. “Even my nephew, he thought he would have to claim something on his taxes when he didn't have a sales transaction.”
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Long- vs. short-term capital gains
A stock sale results in either a gain or a loss, and your brokerage will send you a 1099-B form that you’ll need to file your taxes. The form lists basic information about your stock sale, such as the date when you sold the stock and the “basis” for the shares, which is the price you paid for the stock. That will help you compute your capital gains tax.
The amount of tax you’ll pay will depend on two things: The length of time you held the stock and your income.
“If you held it over a year and sold it, then it's long-term capital gains tax,” says Robert Conzo, a certified financial planner and CEO of The Wealth Alliance, an investment advisory firm with about $1 billion in assets under management. “If it's less than a year, it's short-term capital gains tax.”
There’s a significant difference between the tax rates, since the IRS treats long-term gains more favorably. Short-term gains are taxed according to your tax bracket, with the top marginal rate topping out at 37%.
Most investors, however, won’t pay a tax rate higher than 15% on their long-term capital gains. Single taxpayers who earn up to $40,000 a year pay no tax at all, while single earners from $40,001 to $441,450 pay 15%. Single people who earn above that pay 20%. (There are slightly different income thresholds for other taxpayers, such as married couples filing jointly, which you can see here.)
Oh, and there’s one other catch: High-income investors may also be on the hook for the net investment income tax, a levy of 3.8% for single earners over $200,000 and married couples filing jointly with incomes over $250,000.
No tax bill surprises
Investors who have locked in gains can use an online calculator, such as this free one at TurboTax’s website, to estimate what they’ll owe. That’s important to get a handle on now, rather than face a surprise tax bill when you prepare your taxes.
“If they use the calculator, they know what to expect and can put aside the money,” TurboTax’s Greene-Lewis says. “Maybe they can do some other tax moves that can help their tax situation if they are expecting a gain.”
Seasoned traders turn to a strategy called tax-loss harvesting to lower their tax hit, notes Conzo. “Say I bought GameStop and made $100 — that's a short-term capital gain. Say I look in my portfolio and see something else has a $100 loss. I'm going to sell that, realize the $100 loss and offset the capital gain.”
Count your losses
It’s a “very, very powerful” technique for lowering an investor’s tax hit, he added.
Investors should also be aware they will likely pay a capital gains tax to their state, since the majority of states levy such a tax on their residents, although the rates vary.
“People have to understand, when you make money, you’ll owe the IRS taxes,” Conzo says. “And when you trade and made big money on GameStop, you should put money aside, or do a tax projection at some point during the year to determine your potential tax liability that you'll need to pay by April 15 of next year.”