The GameStop stock saga will undoubtedly go down in history as one of the most mystifying market events Wall Street has ever seen. Indeed, the markets have seen a massive influx of new retail investors into the space. But many of these investors have not previously participated in the market.[1] As noted by CNBC:
There were 3.7 million downloads of Robinhood in January, according to app market intelligence firm SensorTower, even with the millennial-favored stock trading app’s unpopular decision to put trading restrictions on a handful of stocks during GameStop’s climb. After the GameStop drama in February, downloads are still tracking strongly with 1.8 million month-to-date.[2]
It is clear that these new investors are here to stay, but one question often remains unanswered for new investors, do I owe tax on all of this? The short answer is yes, but the answer can be quite more nuanced.
Generally, the Internal Revenue Code allows the government to tax the profit made on certain types of asset transactions (capital assets). See I.R.C. § 1(h). This is what is commonly known as “capital gains” tax. When you sell a capital asset, the difference between the “adjusted basis” in the asset and the “amount realized” from the sale is a capital gain or a capital loss. Generally, an asset’s basis is its original cost to the owner (i.e., the price paid for your GameStop stock), but if you received the asset as a gift or inheritance, other basis rules may apply. A capital gain will occur if you sell the asset for more than your adjusted basis, and you have a capital loss if you sell the asset for less than your adjusted basis.
But not all capital gains and losses are the same. Many taxpayers are already aware of the “beneficial” tax treatment of certain capital transactions, but many taxpayers do not understand exactly how to take advantage of beneficial capital gains rates. Indeed, The Internal Revenue Code differentiates “short-term” capital gains/losses and “long-term” capital gains/losses. See I.R.C. § 1222. Generally, a taxpayer that holds the asset in question for more than one year will get “long-term” capital gains treatment, and if held for one year or less, the asset will get “short-term” capital gains treatment. Different rules do exist for assets obtained by gift, devise, etc. This characterization is important because it carries significantly different tax outcomes for the taxpayer.
In determining net capital gain, you reduce your long-term capital gain for the year by the amount of your net short-term capital loss for the year (if any). The term “net long-term capital gain” means long-term capital gains reduced by long-term capital losses including any unused long-term capital loss carried over from previous years (more on carry-overs below). Any remaining long-term capital gain is taxed at a preferential tax rate, typically only 15%. However, as little as a 0% rate or as high as a 20% rate may apply to a taxpayer’s long-term capital gains depending on the taxpayer’s total income for the year. A 28% rate may also apply to specific transactions as well (i.e., sale of collectibles such as coins and art). But if losses exceed gains, the amount of the excess loss that you can claim to lower your taxable income (ultimately reducing tax owed) is the lesser of $3,000 ($1,500 if married filing separately or single) or your total net loss shown on line 21 of Schedule D (Form 1040). Any excess loss over this limit can be carried-forward in future years, and in some circumstances carried-backwards, to offset capital gains.
“Net short-term capital gain” means the excess of short-term capital gains for the taxable year over the short-term capital losses for such year. Any net short-term capital gain is taxed at the taxpayer’s “ordinary income” graduated rate (i.e. the applicable federal income tax rate for your income/filing bracket).
So what does this all mean for you, the savvy retail investor who made a quick dollar on GameStop? You are likely going to be taxed on your capital gain from the sale of any GameStop stock at your typical income rate. This may come as a surprise to some new investors, as many believe that all stock transactions are taxed at a preferential capital gains rate. Furthermore, some taxpayers with significant capital gains that are not covered by the taxpayer’s tax withholdings for the year may need to make “estimated tax payments” during the year, or they will face a failure to pay estimated tax penalty come filing season. For the investors out there that may have incurred a loss, however, you may be able to deduct a portion of that loss to offset your taxable income for the year, resulting in a larger refund or diminished tax liability. And any loss that cannot be used for the 2021 tax year can be used in future years to offset capital gains and income.
However, there are seemingly endless exceptions to these rules, and there are certain planning strategies that may benefit taxpayers. An experienced CPA or tax attorney will help ensure you get the most from your income.
Need assistance in managing the business planning processes? Freeman Law advises clients with corporate and other entity formations and reorganizations. Restructuring entities—through conversions, mergers, and liquidations—can involve particularly complex tax and regulatory considerations. Freeman Law provides experienced tax and business counsel, helping our clients achieve their organizational goals in a tax-efficient manner. Schedule a consultation or call (214) 984-3000 to discuss your corporate structuring or business and tax planning concerns.
[1] Maggie Fitzgerald, The GameStop mania might be over, but retail investors look here to stay, CNBC (February 13, 2021).
[2] Id.
