Virtually everyone who earns money eventually crosses paths with the Internal Revenue Service. This reality is quickly dawning on American investors who began using apps such as Robinhood during the pandemic to buy and sell stocks when they were cut off from other activities. Approximately 8,000,000 individuals opened up new brokerage accounts in the first three quarters of 2020. Many of them were young people or first-time investors, and some are now facing tax penalties. Additionally, some may be a bit confused about the rules, such as 19-year-old investor Chase Alford, who, according to the Bloomberg Daily Tax Report, recently received an alert from Robinhood, letting him know that tax season was approaching.
Making Sense of the Internal Revenue Code
Not surprisingly, the best person to decipher IRS rules and regulations is a qualified tax attorney. However, there are a few simple facts that everyone should know. For example, speculative trading is clearly penalized according to the Internal Revenue Code. This is done by applying a higher capital-gains tax rate to short-term gains than long-term ones. To enjoy the lower rate, stocks must be kept for a minimum of 366 days. There is a sliding scale applied to long-term capital gains which ranges from 15 to 23 percent. Short-term gains, on the other hand, are taxed at the top rate of 37 percent. For this reason, individuals who made significant short-term gains last year may owe substantial taxes in 2021.
Boom in Brokerage Sign-Ups Last Year
Many people have the misconception that as long as they do not withdraw the money, they won’t be taxed. This is true for 401(k) style plans, but not for the selling of stocks and bonds or gains from mutual funds. Nevertheless, last year saw a massive boom in brokerage sign-ups, with a fifth of stock volume in the United States coming from individual investors. According to a BrokerChooser survey, this phenomenon was worldwide, with trading accounts around the globe tripling from 2019 to 2020.
Generating Losses to Offset Taxes
Although investors hate to sell at a loss, such losses can sometimes erase any taxes owed on gains. Additionally, losses can also counterbalance up to $3,000 in regular yearly income. It is also possible to carry losses over to future years. This is sometimes referred to as “tax loss harvesting,” but it comes with a catch: the loss cannot be claimed on taxes if the stock is sold at a loss, but then repurchased within 30 days. This rule was implemented to stop taxpayers from manipulating the system.
Why Avoiding the IRS Is Difficult
The IRS receives a copy of every 1099 for American citizens. This means they know how much investors made, even if the investors do not claim the gains on their tax returns. For this reason, it is important to report all income from investments and pay off any amounts owed as quickly as possible. If the appropriate forms are used, tax software can usually determine how much is owed. However, those who trade without knowing the tax rules in advance may end up with much larger bills than anticipated.
Robinhood, the company that became somewhat famous during the pandemic, stated that it is not authorized to provide tax advice, as it is a self-directed brokerage. The company recommends that consumers speak with tax attorneys to have specific questions answered.
For some individuals, the extra money owed from trading will merely result in a smaller refund, but unexpectedly large tax bills may loom for investors who earned substantial money from stocks in 2020. The good news is that Uncle Sam typically allows filers to make payment arrangements on overdue taxes. The downside is that interest and tax penalties may still apply. The best option for those facing IRS problems in 2020 is to speak to a qualified tax attorney without delay.
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