People Who Made Money On GameStop Have A Really Big Tax Bill Coming

Stock market jargon rarely makes its way into everyday conversation. But after a group of Reddit users manipulated the price of stocks such as GameStop, AMC, and Blackberry, reaping huge gains overnight, it seems like everyone is talking about short selling and hedge funds.

Some investors joined the action early enough to cash in big-time on these so-called “meme stocks” (others, not so much). It’s enough to tempt even the novice investor into dabbling in day trading, with hopes of pegging the next GameStop. But not only is this type of speculative trading hazardous, but it can also be expensive from a tax perspective.

“Massive gains are great, but the recent trading frenzy is going to bring out a lot of short-term taxable gains, which have a much higher tax liability than the long-term capital gains many investors may be used to,” said Tony Molina, a certified public accountant and senior product specialist at Wealthfront, in a statement.

The good news is that there are ways to offset these gains and potentially lower your tax bill if you happen to get lucky.

Here’s what you need to know about the tax consequences of short-term stock trading and how to minimize the cost.

The amount of taxes you pay on stock transactions is dependent on whether it’s a short-term or long-term capital gain, explained Lisa Greene-Lewis, a certified public accountant and expert with TurboTax.

If you sell stock that you’ve held onto for more than a year, you will be taxed on the earnings at a lower capital gains rate. Here’s what the capital gains tax rates are currently for single filers:

• Income of $0 to $40,000: 0%
• Income of $40,001 to $441,450: 15%
• Income of $441,451 or more: 20%

However, if you held that stock for less than a year, the gains are taxed as ordinary income according to whichever tax bracket you fall under. Here are current tax brackets for single filers:

• The income of up to $9,950: 10%
• Income of $9,951 to $40,525: 12%
• Income of $40,526 to $86,375: 22%
• Income of $86,376 to $164,925: 24%
• Income of $164,926 to $209,425: 32%
• Income of $209,426 to $523,600: 35%
• Income over $523,600: 37%

Lewis shared this example: Say your taxable income for the year is $50,000, including a $5,000 gain on a stock you sold. If you owned that stock for at least a year before selling it, the tax on that sale would be $750 (15%).

However, if you owned the stock for less than a year, you’d pay ordinary income tax on the profit, based on the tax bracket you fall into. In this case, that would be $1,100 (22%).

Keep in mind that if you make a lot of money from stock sales in one year, you could bump yourself into a higher tax bracket and thus, increase your capital gains rate. You can use a capital gains tax calculator like this one from TurboTax to help you understand the differences between your short-term and long-term capital gains and losses on your transactions.

Giving up a chunk of your stock market earnings to the IRS certainly isn’t fun. Fortunately, there are a few ways to lower your tax liability and decrease your overall tax bill.

For example, if you have other securities trading at a loss, Molina said you could actually use those to your advantage. “By selling securities at a loss, you can use those losses to offset your other capital gains,” he stated. “This strategy is called tax-loss harvesting and can limit your tax liability over the long term, especially in volatile markets like we currently see.

Another way to offset capital gains is by contributing more pre-tax funds to your 401(k) or other retirement savings account, which will reduce your adjusted gross income and maybe even keep you in a lower tax bracket. The 401(k) contribution limit for 2021 $19,500, or $26,000 for employees over 50 making catch-up contributions.

Finally, Molina suggested holding off on other financial moves that would increase your tax burden even more. “For example, if you hold company equity, you may consider waiting to sell any until you’ve held it for a whole year, which results in a lower tax rate as a long-term gain instead.”

And if you believe you will still owe quite a bit at tax time, Lewis recommended making quarterly estimated tax payments to avoid any surprises.