Report: New Investors Are Learning Robinhood Tax Implications The Hard Way

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2020 was a banner year for brokerages of all shapes and sizes. But now new investors are learning the tax implications that come with DIY day-trading apps like Robinhood.

During the stock market rollercoaster and rally of 2020, at least eight million people opened new brokerage accounts in the first three quarters of 2020. Day-trading in the stock market during pandemic-related swings became the “new” sports betting.

But now with 2020 tax bills due to Uncle Sam, many first-time investors in their 20s and 30s are learning the headaches that comes with these popular trading platforms when it comes to minimizing one’s tax liability.

Morningstar recently reported on Robinhood tax implications via a cautionary tale of one do-it-yourself trader. This trader transacted in over $45 million in total trades, amassing a net profit of only $45,000 over the course of the year.

Robinhood Tax Implications – A cautionary tale

According to the report, this specific 30-year old investor reached out to a financial planner upon the realization that they owe a $800,000 tax bill. The investor, who works a full-time 9-to-5 in insurance, was new to the market and didn’t realize the implications that come with short-term capital gains. A Forbes summary of the Morningstar report says that at one point this investor was doing $200,000 and $2 million trades per day, with a trading volume of 10 and 50 trades daily.

As the old saying goes, death and taxes are the only two certainties in life.

Now many that it’s time to file and pony up, many new traders are learning the hard way that it isn’t as simple as a job withholding pay.

The Wash Sale Rule

A Bloomberg article on the tax implications for retail traders lays out the Xs and Os of the IRS’s “wash sale” rule. This tax regulation prohibits the sale of a stock to use the loss deduction, only to purchase the same stock, or similar, within 30 days. Investors must wait at least 31 days before repurchasing the same investment, according to Forbes.

“If people are going in and out of names quickly, and they’re generating losses and have offsetting positions, they’ve generated those losses within 30 days of a purchase, those losses get suspended,” explained Sandi Bragar, managing director at Aspiriant.

In the same vein, a recent Wall Street Journal report summed up the tax implication “pitfalls” of new, extremely popular investing apps like Robinhood. It lays out a compelling case for why all investors should be aware of “wash sale rules”, which can be laid out when working with a professional financial planner. The functionality for is commonly built into more established brokerage.

With 2020 tax bills coming due, a wave of new retail traders are waking up to the fact that it can be difficult, and often impossible, to make tax-minimizing moves on new brokerage platforms such as Robinhood, Webull, SoFi, Uphold and Public.com. Some don’t allow trading within tax-favored retirement accounts such as IRAs. Traders can also find it hard to track their “wash sales” that reduce tax benefits if they buy a stock within 30 days of selling the same stock at a loss.

The Wall Street Journal article chronicles the experience of a 43-year-old Robinhood user who’s account has amassed about $238,000, “mostly in Tesla stock.” This investor notes that Robinhood puts “all shares of a stock into one big bucket” and says he stopped using the app because “I’m haunted by my 2020 capital-gains tax.”

Most vexing for investors like Mr. Leong is that despite the new platforms’ sophisticated technology they don’t make it easy to deploy a tax-wise technique known as “specific-lot identification.” Investors use it to lower their taxes, sometimes significantly, by choosing which shares to sell if they have lots bought at different prices and aren’t selling all of them.

Every investing strategy needs a tax plan

It’s a harsh reminder that the ease of a user-friendly trading experience can come with costly tax hits if you don’t know what you’re doing. Free trading apps come with a price.

A poster of the Boglehead forum sums up how the Robinhood gold rush can come with a cost:

My observation is the typical Robinhood user doesn’t put any thought into taxes and many have probably never paid any income tax beyond paycheck withholdings. Most 20-30 year olds, the Robinhood demographic, are used to tax day being a payday for them. The idea that you might have to actually write a check on April 15 would come as a shock to many.

Like all investments and calculated risks in life, think through the tax consequences that can come with using these apps and investment strategies and have a plan.

Mark Steber, chief tax information officer at Jackson Hewitt Tax Service, puts it perfect, via:

“Anything that is gain or that you’re happy about, there’s probably a tax consequence. And the more of those you have, the bigger the tax consequence, often with a surprise.”

Author
B. Carlisle

Contributing editor at Wealth Gang. An entrepreneur at heart, he's passionate about meaningful ways to leverage technology and social media for business opportunities and side hustles.