Much of America — and other parts of the world — was caught up in the excitement of the investment success of the /r/WallStreetBets Reddit forum in late January, in which a bunch of small-scale investors identified a weak spot in the stock market and successfully exploited it, creating a bunch of individual rags-to-riches stories. People who timed investment in GameStop correctly made a lot of money.
Now that the dust has settled a little and some savvy investors are seeing sudden big balances in their checking account, there’s one important thing to consider. Taxes.
Do I have to pay taxes on money earned while investing?
Yes. If you bought and profitably sold shares of GameStop, taxes will need to be paid. The brokerage(s) you used to buy and sell shares will report that information to the IRS, and you will owe income taxes on it. However, you should focus on the word “earned” here, because it’s important.
[ See: How to Explain Reddit Stocks to Your Kids ]
Let’s say you bought 10 shares of GameStop at $ 5 per share without fees, then sold it at $ 300 per share without fees. Your initial cost for that investment was $ 50, but you withdrew $ 3,000. For that investment, your gain was $ 2,950, and that’s what you will owe taxes on.
What if you were charged a fee to buy and to sell? Let’s say the fee was $ 5 to buy and $ 5 to sell. In that case, you bought 10 shares of GameStop at $ 5 a share and paid a $ 5 fee. This means your basis is $ 55 — the amount you paid for the asset, including fees and commissions.
Then, if you sold the investment and made $ 3,000, but you were charged a $ 5 fee there, too, you actually earned $ 2,995. That’s your realized amount — the money that wound up in your account after fees and commissions.
So, in that situation, you would owe taxes on $ 2,940: the result of subtracting the basis from the realized amount.
It is very important to note that if you lost money on another investment, you can use it to counterbalance these gains. So, if you bought 100 shares of AMC at $ 15 a share and sold them at $ 8 a share, you lost $ 700. So, you would be able to subtract the $ 700 loss from the $ 2,950 gain, meaning you only owe taxes on $ 2,250. If you lost more than you earned, you can use capital losses to offset up to $ 3,000 of other income, such as normal earnings, and you can carry unused capital losses forward to future years, so if you lost $ 9,000 in total, you could carry forward $ 6,000 in losses to use in the future.
Another important thing to consider is whether these are long-term or short-term gains, which change the tax rate you need to pay.
Short-term capital gains
What are short-term capital gains?
If you held an investment for only a year or less before you sell it as a gain, it is considered a short-term capital gain. So, for example, if you bought shares in GameStop on January 12, 2021, and sold them on January 28, 2021, that’s a short-term capital gain. Almost everyone that earned a quick profit from buying and selling GameStop will owe short-term capital gains taxes.
[ Read: 12 Things to Know Before Investing in Stocks ]
What if I made short-term gains?
Currently, short term capital gains in the United States are taxed as normal income. You would simply add your investment income to your total income for the year and pay taxes normally on that income. Your exact percentage depends on what tax bracket you’re in based on your overall income.
It’s important to note that short-term losses offset short-term gains. So, if you lost money on a short-term investment, you would subtract it here, up to the total amount that you gained.
If you are concerned about how to manage capital gains taxes in your own specific situation, contact a tax professional who can help you with the specifics.
Long-term capital gains
What are long-term capital gains?
If you held an investment for more than a year before you sell it as a gain, it is considered a long-term capital gain. So, for example, if you bought shares in GameStop on January 12, 2020, and sold them on January 28, 2021, that’s a long-term capital gain.
What if I hold and make long-term gains?
Long-term capital gains in the United States are charged a lower interest rate than short-term capital gains. Depending on your income, they’re charged at either a 0%,15% or 20% rate. Here are the current long-term capital gains tax rates.
| Tax filing status | 0% rate | 15% rate | 20% rate |
| Single | Taxable income of up to $ 40,000 | $ 40,001 to $ 441,450 | Over $ 441,450 |
| Married filing jointly | Taxable income of up to $ 80,000 | $ 80,001 to $ 496,600 | Over $ 496,600 |
| Married filing separately | Taxable income of up to $ 40,000 | $ 40,001 to $ 248,300 | Over $ 248,300 |
| Head of household | Taxable income of up to $ 53,600 | $ 53,601 to $ 469,050 | Over $ 469,050 |
It’s important to note that long-term losses offset only long-term gains. So, if you lost money on a long-term investment, you would subtract it here, up to the total amount that you gained.
Again, if you are concerned about how to manage capital gains taxes in your own specific situation, contact a tax professional who can help you with the specifics.
Earned income tax credit implications
What is the earned income tax credit?
Another important aspect of taxes with GameStop profit is the Earned Income Tax Credit. The Earned Income Tax Credit is a tax credit given to low- and moderate-income households, particularly ones with children. It’s an actual tax credit, which means that it reduces the amount of taxes you owe to the IRS, which can result in either a much smaller tax bill or a much larger refund.
There are a lot of rules for qualifying for the Earned Income Tax Credit. The biggest requirement is that minor income is relatively low, but the threshold for qualifying jumps quite a bit for each child in your household. Also, the amount you can claim jumps substantially if you have children, up to as much as $ 6,728 in 2021 if you have three or more qualifying children.
How investment gains affect the earned income tax credit
There’s a big drawback to this Earned Income Tax Credit, however. Your total investment income must be $ 3,650 or less to qualify. Thus, if you have more than one qualifying child and would otherwise qualify for the Earned Income Tax Credit, if you only slightly exceed that threshold, you will actually lose money because the tax credit is larger than your total investment income.
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What if I lose the earned income tax credit?
If you lose the Earned Income Tax Credit solely because of your investment gains, then it simply means that you will owe a larger tax bill than you would have otherwise owed because that credit goes away. If you are close to the cutoff, a small investment loss would get you below that level, so you may want to consider making another small investment such that, if you lose money on it, you would at least restore your earned income tax credit for the following year.
For example, if you qualified for the EITC in 2020 and it looks like you would qualify for it again in 2021 except that you earned $ 4,000 in investment income, consider using some of your investment income to invest in other short-term investments. If those pay off, then your investment income is high enough that the loss of the tax credit isn’t a big deal. If those show a loss, sell them when they would bring your investment income total below $ 3,650. This is not worth doing if you have a very large investment income, as you would have to lose a lot of money in investments in order to recoup a fairly small tax credit — this only makes sense if you’re close.
If you are concerned with the Earned Income Tax Credit in your own specific situation, contact a tax professional quickly. They can help you work through the specifics of your own tax situation.
Make a plan before you spend
In any case, if you made some investment income from making Wall Street bets, congratulations. However, rather than splurging with that money, consider using it in a way that will make things better for you going forward.
Plan for taxes
First of all, make absolutely sure you’ve put aside plenty for taxes. Since this is likely a short-term capital gain, you’ll want to use a tax calculator to see how much you’ll owe in taxes when you file next spring. Intuit’s tax calculator will help you get an approximate estimate of your tax bill. Just make sure you hold onto at least that much of your income. This is the most important thing, as you do not want to get stuck with a tax bill next April.
Build an emergency fund and pay off debts
What about the rest of your investment income? You should start by taking steps to solidify your financial foundation so that you can weather anything life might throw at you – illness, job loss, and any other unexpected event. Start by creating an emergency fund, which is just a pool of cash stowed away in a savings account for unexpected events. A good amount to store is a month of living expenses.
Once you have that in place, pay off your debts. First, make sure you’re up to date on all of your bills. Then, construct a debt repayment plan to help you figure out which debts to tackle first, and make a big extra payment on the one at the top of the list. If you did really well, pay off debts in their entirety going down the list. Seeing credit card debt and student loans simply vanishing into thin air is a lasting burden off your shoulders.
[ For You: 7 Life-Changing Ways to Use Your Tax Refund ]
Build a financial foundation
What if you’ve got an emergency fund and are debt free (or just have very low interest debts remaining)? There are a lot of options to consider when deciding what to do with your newfound money. Consider using this money to build a lasting financial foundation for you and your family. Identify what your long term goals are. Do you want to own a house? Do you want to pay for your child’s college education? Do you want to retire early? Figure out what is meaningful to you in your life, then seek out specific financial advice on how to best invest for that goal.
Too long, didn’t read?
If you did well with making Wall Street bets in January, congratulations! However, you need to keep in mind that your big boon comes with tax consequences. You’ll owe taxes on your gains and, in some situations, it can also cause you to lose a very valuable tax credit. Start planning ahead now so that you’re not shocked next spring.
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