Executive Contacts
The COVID-19 pandemic initiated a surge of new investors toward app-based trading platforms for their investment needs. These platforms allow investors to create their own brokerage accounts and self-manage their portfolios.
Prior to the pandemic, most investors relied on financial institutions to manage the day-to-day activity of their investment portfolios. Such institutions usually provide annual summarized statements and forms, easing the burden of tax compliance. However, the institutions charge brokerage fees on day-to-day management and certain transactions. These brokerage fees tend to add up quickly and are paid through the investment account, which reduces portfolio growth.
Tax Compliance
App-based trading platforms, such as Robinhood, put millions of investors in control of their own portfolios. Many investors enjoy the thrill of day trading but don’t understand how it impacts their taxes. The following rules apply to investment transactions:
- Realized gains (gains from the actual sale of an investment security/stock), capital gain distributions, and dividends are taxable in the year of the transaction.
- Long-term capital gains (investment securities/stocks held for more than one year) are taxed at a rate of 15% – 20% depending on the investor’s total income.
- Short-term capital gains (investment securities/stocks held for less than one year) are taxed at the ordinary income rate of the investor (the average individual faced a net average tax rate of 22.4% in 2020 according to the Center for Tax Policy and Administration. The highest individual marginal tax rate was 37%, according to the 2020 federal income tax bracket).
- Realized investment losses (losses from the actual sale of an investment security/stock) are deductible to the extent of realized gains. Any capital losses above capital gains are limited to $3,000, with the excess losses carried over to the following years.
In addition, the “wash-sale rule” adds further compliance requirements for investors who use app-based trading platforms. The rule is designed to prevent investors from “gaming” the system (sell security/ stock to realize a tax loss, only to purchase a substantially identical security/stock soon thereafter). Losses from such sales are not deductible in most cases and are suspended to future years. Tracking “wash sales” can be a difficult task in app-based platforms. Most platforms do not support identification of substantially identical securities/stocks, and therefore the investor may not be aware that he or she has purchased a substantially identical security/stock.
Best Practices
Below are some recommended best practices for app-based platform investors:
- It is important for investors to carefully track their purchases and sales.
- Thinking through the timing of sales will help investors manage tax consequences.
- Investors should set aside a portion of proceeds to pay future tax liabilities and stay in compliance with Internal Revenue Service regulations.
If you would like to speak with a tax professional about tax compliance for app-based trading or any matter involving tax planning and strategy, one of our executive contacts would be happy to assist. You may email them below, or call (800) 270-9629.
