Matthew Savello, a certified public accountant, spends his days answering questions about filing taxes in about 15 investing and stock groups on Discord, a popular chat service for young investors. He works full time at an accounting firm but has now also launched his own advisory, Prestige Tax & Accounting LLC.
“Now that it’s actually coming time to file, people are starting to scramble a little bit,” said Savello, 27. “One of the key things is you have to budget it. Probably most of the people I talked with actually have losses, there’s not many who can actually pull this off successfully. And for the ones who do, budgeting has become quite an issue.”
Robinhood — the company that’s become synonymous with the retail investing phenomenon over the past year — says it recommends that its customers speak with a tax professional for specific questions about tax documents, including how to file. It’s reaching out to users to update them on the information they can expect to receive from the company in preparation of tax season, including an overview of key dates and tax forms, according to a spokesperson.
Filing as an investor can mean collecting a lot more paperwork. There’s the 1099-B form from brokers, the 1099-INT reporting interest income, and the 1099-DIV for dividends. Some firms consolidate all activity on one form. It might take until mid-February for your 1099-B to arrive, and other specialized forms, like the K-1s generated by partnership investments, take even longer. Those who trade cryptocurrencies or who jumped from platform to platform in 2020 might need to do extra work to compile all the taxable transactions they need to report.
The IRS gets a copy of every 1099. If you don’t report every cent of income, the agency will notice and send a letter demanding money. In many cases, the IRS’s computer could end up charging much more than you actually owe — for example, by taxing the entire proceeds of a sale, rather than just your gain.
“It’s to your benefit to pay it off as quickly as you can,” said Jordan Kendall, a partner at Marcum LLP. Ignoring your filing obligation altogether could be even more of a hassle.
“Many taxpayers don’t realize that if you’re delinquent in tax filings and you owe the government money, they could withhold your passport and stop you from traveling internationally,” he said. “They could make your life difficult.”
If you enter the right forms, tax software can generally figure out how much you owe. But if you’re trading without knowing the tax rules, you can end up with a much bigger tax bill than expected.
2020's Trading Surge
In addition to lowering taxes by holding onto investments for more than a year, savvy investors can avoid them entirely by generating losses. By selling stocks that have dropped in value, they can offset any gains in their portfolio. It’s something amateur investors are often reluctant to do.
“Selling at a loss, particularly, is the hardest move for new investors to make,” said Linda P. Erickson, a financial planner at Erickson Advisors in North Carolina. “They seem to always want to wait until it ‘comes back.’”
Losses can not only erase taxes on gains, they can also offset up $3,000 per year in ordinary income. Losses can also be carried over to future years. However, there’s a catch to this strategy, often called “tax-loss harvesting”: If you sell a stock at a loss, and then buy the stock again within 30 days, you can’t claim the loss on your taxes.
The so-called “wash-sale rule,” designed to prevent taxpayers from gaming the system, could pose a problem for novices who spent 2020 trading in and out of the same few stocks. Their investments may have lost value, but they won’t be able to claim a loss on their 1040 form.
For many, the extra tax costs of trading might just mean a smaller refund. Those who made substantial money in 2020, however, may find themselves with unexpectedly large tax bills. The good news is that the IRS allows people to pay taxes by installment with only a little bit of extra paperwork. The bad news is that penalties and interest can apply.
This article was provided by Bloomberg News.