Made money off your GameStop stocks? Wait for the catch: Taxes

If you’re among the army of retail investors who have made big money trading in shares of GameStop and other previously downtrodden stocks, one thing is certain: The taxman will come.

Trading by small investors caught fire in 2020, as boredom brought on by pandemic lockdowns combined with convenient, no-fee mobile investing apps like Robinhood.

In recent weeks, some of those investors, fueled by social media chatter, have driven up the price of GameStop, a brick-and-mortar video game retailer that has been losing money. Their reasons for buying the stock vary, but some wanted to thwart the big investors that were betting that the share price would fall — otherwise known as shorting the stock. Trading in other mundane stocks, like Blackberry and the AMC theatre chain, has surged as well.

Some individual investors may already have notched tens of thousands of dollars in profits — even millions, if online boasting is to be believed — as share prices soared.

Here’s the thing: Those investors may have to pay hefty capital gains taxes. The gains are on paper, of course, until the holder sells the shares, said Rhonda Collins, director of tax content and government relations with the National Association of Tax Professionals. And taxes for stock sales occurring this month wouldn’t be due until April 2022.

Read | Meet the 10-year old who made a 5000% return on his GameStop investment

If those investors want to cash in on their gains, they may be caught off guard by how much they owe the government, accountants say. Unlike with employment income, there’s no automatic deduction of taxes.

“That’s my concern,” said Darren Neuschwander, managing member of Green, Neuschwander & Manning, which specializes in tax compliance for traders. Younger investors new to trading, he said, may not fully consider taxes and may be tempted to spend much of their windfall. “They better be putting some aside.”

Tax calculations are complicated.

Someone who bought and sold GameStop shares quickly, in the midst of the trading frenzy that began in early January, would probably pay very high tax rates.

Short-term gains — those on shares held for less than a year — don’t get favourable tax treatment, but are taxed as ordinary income. Rates vary by your tax bracket (there are seven, depending on your income and filing status), starting at 10% and rising as high as 37%. There is also an extra 3.8 % “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%.

Also Read | The misfits shaking Wall Street

Say a high-income investor bought 100 shares of GameStop on Jan. 4, when the shares traded at $17.25, paying $1,725. Then, the trader sold the shares on Jan. 27, when they hit $347.51, reaping $34,751, for a gain of $33,026. The tax bill for someone in the top income bracket would be an estimated $13,475.

And that’s just federal taxes. Many states and cities assess their own capital gains taxes or treat capital gains as ordinary income, which is taxed at higher rates.

Some GameStop traders have indicated that they bought shares in 2019 and have held them for more than a year. In that case, they would be eligible for favourable long-term capital gain tax rates if they realized a gain upon selling. The top rate would be 20%; higher earners would also pay the extra 3.8%, for a rate of 23.8%.

Individual traders may also have capital losses if they sell a stock for less than they paid for it, which can be used to offset capital gains and reduce taxes, said Tony Molina, a certified public accountant and senior product specialist at Wealthfront, an online investment service.

Less experienced investors may sometimes run afoul of tax rules with so-called “wash sales.” In this scenario, an investor with a large capital gain on the sale of one company’s stock seeks to generate a loss to offset the tax bill. So the investor sells shares of a different stock at a loss — but then quickly buys back the stock. That’s a no-no.

Also Read | Reddit vs Wall Street: A glorious game of 'stonks'

“You can’t do that,” said P. Evan Stephens, a tax partner with Sensiba San Filippo in San Jose, California, If you buy back the same or similar stock back within 30 days, he said, you can’t use the loss generated to offset your gain.

On the radar is a proposal by President Joe Biden to eliminate the favourable long-term capital gains rate for taxpayers earning more than $1 million, and to increase the top tax rate for ordinary income. There have even been rumblings that the changes, if approved, could be made retroactive to the start of 2021. “Is it likely? No,” said Tim Speiss, a partner with EisnerAmper’s personal wealth group. “Could it happen? We don’t know.”

Investors looking ahead to next tax year may want to consider paying taxes periodically throughout the year to avoid underpayment penalties, said Randy Abeles, a certified public accountant in Chicago and a member of the American Institute of CPAs personal financial specialist committee.

Tax documents for trades in 2020 will be arriving in inboxes soon, before tax filing season, which begins on Feb. 12. If you traded through a brokerage, you’ll probably receive a statement called a 1099-B, which typically lists information like the date shares were sold and, in many cases, the “basis,” or the value when you acquired the stock, which is used to compute your gain.

Who knows what will happen to GameStop’s stock over the next days or weeks? But if you decide to cash in on your gains, there is no doubt that there will be tax consequences.