Some Robinhood Traders' Next Big Transaction Is With the IRS
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How could GameStop-era trading lead to a big tax bill from the IRS?
Here's your money briefing for Monday, February 8th. I'm J.R. Whelan for The Wall Street Journal. By now, you've no doubt heard stories about people who've jumped into the recent stock trading frenzy and made big bucks by buying and selling shares of companies like GameStop as the price shot up. Well, pretty soon, they might be surprised to learn that their next big transaction could be with the IRS.
Really, the time to think about this is before you sell. And so people need to be setting that money aside or at least having a plan for how to pay those taxes.
Coming up, our tax reporter Laura Saunders will explain how buying and quickly selling stock can drive up your tax bill. And we'll hear from a 23-year-old Robinhood trader who's facing a hefty tax bill of his own. That's after the break.
GameStop, AMC, Bed Bath & Beyond, these heavily traded stocks have made some retail investors a lot of money in just the past few weeks. But scoring quick cash can also mean a huge tax bill that many people aren't ready for. In a moment, we'll check in with a young Robinhood trader from Atlanta on his experience. But first, let's bring in our tax reporter, Laura Saunders, for more on what trades like these can mean for your taxes. Laura, thanks for being with us.
Thanks so much for having me.
What key differences exist between investment income and wage income for taxes?
So let's start with the basics. How is this kind of investment income taxed differently from, say, a job?
Well, it's really very different, and people need to be aware of this. And two things I think are especially important to stress, something that may seem pretty good is that you don't owe payroll taxes on it. That's Social Security and Medicare tax. That's unemployment income or self-employment income. So this is investment income. That's very different. You don't owe. That can come up to 15.3%, and you don't owe that. You don't have to pay it. One of the other things that's important and can be a bit of a trap is that there's no withholding. There's no way to withhold on your winnings. So if you get a pension check or a Social Security check or a paycheck, you either must or you can have money withheld to pay your taxes.
In this case, you're going to have to pay taxes and you better set aside the money to pay the taxes so it doesn't come as a big surprise on April 15th.
Now, people trading GameStop shares bought and sold at a pretty quick pace as the share price changed.
Why is lack of withholding a trap for frequent retail traders?
That's how they're able to make money. But can that type of trading run up their tax bill?
Oh, in so many ways. And a lot of these young traders are not thinking about taxes, and they should be thinking about taxes. Well, there are rules. The first thing is that these people are mostly trading in taxable accounts. These people, millions of them, have old-fashioned retail trading accounts, which means that every trade is potentially taxable and will be reported to the IRS by your broker. And so you have to deal with the paperwork at the end of the year. That's the first thing. Now, the second thing is that if you hold a position for less than a year, then you have to pay much higher tax rates. You pay the same rate that you would pay on your wages. And then you have state taxes on top of that.
So Uncle Sam can take a pretty big bite out of your winnings.
Can you break that down a bit more?
How do short-term vs. long-term capital gains affect tax rates?
How does the IRS treat those numbers, you know, tax rates on long-term and short-term investments?
So if you hold for a year or longer, the rates are much lower. It could be zero or 15% or 20% up to maybe 23.8%. So that's a pretty low rate. Now, if you hold for less than a year, then you have a short-term capital gain. And that's taxed at ordinary income rates. And that's the same as your wages. So the tax rates there go from 10%, not 0%. 10% to 37%. And if you are in California and you have state taxes, then you're going to wind up paying more than 50% if you're a top bracket taxpayer in both your federal and state taxes.
Now, we've heard about people who bought GameStop stock options and not shares as a way to make money. Do the IRS rules on gains and losses apply to options as well?
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Chapters
8 chapters
1
How could GameStop-era trading lead to a big tax bill from the IRS?
0:05–1:22
2
What key differences exist between investment income and wage income for taxes?
1:22–2:30
3
Why is lack of withholding a trap for frequent retail traders?
2:30–3:26
4
How do short-term vs. long-term capital gains affect tax rates?
3:26–6:03
5
Are options and other derivatives taxed differently than stock gains?
6:03–7:52
6
What was a young Robinhood trader’s experience and profits during the frenzy?
7:52–9:29
7
How should traders plan to set aside money or pay estimated taxes?
9:29–10:18
8
How can losses offset gains and what carryforward rules apply?
10:18–10:40
Speakers
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