You may have heard the news about how a critical mass of investors drove GameStop’s stock value to unimaginable heights, to the chagrin of wealthier investors who were betting on its decline. GameStop’s meteoric rise in stock value—from less than $20 per share in December to nearly $500 in January, before settling back down to under $100—tracked a spike in demand that had nothing to do with the usual metrics.
This sharp spike in value resulted in a windfall for many investors who chose to sell when it was at its peak. Quite a few of the retail investors who cashed out are day traders and more casual participants in the stock market. These investors may not realize the tax implications of short-term Wall Street gains. If you’re one of those investors, it’s probably in your best interest not to spend it all right away.
A hefty tax bill, this year or next, may be in store for unwitting GameStop investors, and others who have done the same with AMC and other stocks. The tax consequences depend, to some degree, on how long you held the stock before selling, whether your state also levies capital gains taxes, your broader financial situation, and other factors. We’ll explain why GameStop’s share price got so high, the tax implications of making a quick profit on stocks, and more to help you prepare for tax season without too many surprises.
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What caused the GameStop surge?
The price of any public company’s stock is ultimately based on investor confidence and demand. The price per share goes up if there’s high demand for shares. However, while the demand for shares in a company’s stock typically follows the ups and downs of its earnings and future outlook, stocks can be manipulated through other means that have the effect of boosting demand.
Shares in GameStop stock had been waning for a while before the creator of the WallStreetBets Reddit community started buying shares and encouraging others to do so. Meanwhile, many larger and wealthier investors had purchased derivatives to “short” the stock, which earned them money as long as the stock continued its expected decline.
GameStop’s stock began to rise as investors in the Reddit community bought shares through Robinhood and other popular day-trading platforms, which of course snowballed as more and more investors got in on the action. Since the rise in GameStop’s stock price wasn’t based on the underlying financial health of the company, and many investors saw it as a short-term bet anyway, it’s not expected to last.
Will I owe taxes if I sell stock for more than what I paid for it?
Yes. If you earn a profit on the sale of any stock—not just shares of GameStop—then you will owe capital gains tax. This is a tax on the profit that you made when you sold the stock. The profit is the difference between what you originally paid for the stock and what you sold it for. The capital gains tax rate you will pay, as well as when you will have to pay it, depends on certain factors. Your tax bill on stock sales could be as high as 40.8%, which is why it’s so important to get a handle on your tax obligations before you go out and spend it all. Short-term capital gains are typically taxed at a higher rate than long-term capital gains. Let’s discuss the difference between the two types next.
What’s the difference between short-term and long-term capital gains?
Tax law discourages traders from selling recently purchased stocks, often referred to as “day trading.” The goal is to encourage long-term investment in the broader economy and a less-volatile stock market in general. This is why there is such a stark difference in the rates for short-term and long-term capital gains taxes. Here is a brief comparison of the two:
- Short-term capital gains. These include profits on the sale of stocks that are held for less than one year. They are taxed as ordinary income, based on your tax bracket, in addition to a 3.8% “net investment income tax” for individuals earning more than $200,000 per year (or $250,000 for married couples filing jointly).
- Long-term capital gains. These include profits on the sale of stocks that are held for more than one year. They are taxed at varying rates that top out at 20% (compared to 37% at the high end for short-term capital gains), including the 3.8% premium for high-earners.
You may be able to offset some of your capital gains taxes if you also experienced “capital losses,” but you may not sell stock at a loss and then quickly repurchase it for this purpose. Also, the Biden administration has discussed changes to the tax code that would eliminate the lower long-term capital gains tax rate for individuals earning more than $1 million.
It is important to keep in mind that stock earnings (and capital gains in general) count toward your taxable income when determining your tax bracket. If you are in the 10-12% tax bracket (individuals earning $40,000 or less during tax year 2020), you do not have to pay any capital gains tax.
What are some options for paying the taxes owed?
If you sold shares in GameStop, or any company’s stock, in 2021, then rest assured you won’t have to pay taxes on that windfall until 2022. But you will have to pay it, and so you might consider setting money aside now or throughout the year to make quarterly payments to the IRS before the tax deadline in 2022. You will need to make plans to pay taxes in 2021 (or seek an extension or payment plan) if you have capital gains from 2020.
There are some tactics that can help you lower or even defer your capital gains taxes, such as donating stocks directly (if you had planned on making donations to begin with) instead of cashing them out and then donating the proceeds. Another option is to reinvest your earnings into an Opportunity Zone (a designated low income community in need of investment), which will allow you to defer what you owe for five years, but it’s quite complex. It would be best to work with a Certified Public Account (CPA) or tax lawyer to ensure that you are following the appropriate regulations.
If you simply don’t have the money to pay what you owe at the deadline, the IRS offers a few options. These include 120-day, short-term payment plans (which don’t accrue a fee) and longer-term monthly payment or installment plans that accrue user fees. If you owe more than $50,000, you will need to submit a financial statement along with your request for a payment plan. If you’re experiencing a financial hardship, then you may qualify for a temporary suspension of collection.
Understand the tax implications of stock windfalls before you spend it
As Ben Franklin famously wrote, the only sure things in life are death and taxes. If youpulled in profits from selling shares in GameStop or other stocks, your tax liability will likely need to be addressed. Be sure you know how much you’ll have to pay in taxes and set it aside in advance. If you have additional questions about your finances and taxes, talk to an accountant or a Rocket Lawyer On Call® attorney.
This article contains general legal information and does not contain legal advice. Rocket Lawyer is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.