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Retail investors have been the big winners in this recent bull market, buying the March/April dip and enjoying a spectacular run – the S&P 500 index is up over 50% since March – even with the recent market turmoil in tech stocks.
A great deal of them are also new to the market, welcomed by commission-free trading options from Robinhood, and now, the older, more established brokerages.
Some investors may be unfamiliar with the responsibilities that come with winning in the market, which can sometimes mean estimated taxes – due quarterly. The next installment is Sept. 15.
Despite the recent market tumult, many retail investors are very much in the money and are realizing those gains by trading frequently, according to a Yahoo Finance-Harris Poll survey.
Much of this behavior, the survey also found, is happening in brokerage portfolios (not retirement accounts). That means these gains are subject to U.S. capital gains taxes – 0%, 15% or 20%, depending on how much money you make if you sell after a year of holding, or simply ordinary income if you sell a position in less than a year.
"Traders may need to make estimated tax payments if they have recognized significant capital gains this year," Hayden Adams, director of tax planning at Charles Schwab.
For people who have a windfall that doesn’t involve withholding, there can sometimes be penalties, because you’re supposed to pay tax throughout the year, not just a lump sum come tax day.
To avoid the penalties, Adams says traders should either increase withholding or make estimated tax payments.
Generally, says Barry Kleiman, a CPA and principal at New Jersey accounting firm Untracht Early, regular people are often exempt from paying estimated taxes if they experience a big gain in the market during the year if they expect to wipe those gains out by the end of the year — and that people who invest in hedge funds need to pay special attention.
But depending on one’s circumstances, the IRS may be interested, which is why it’s important for people who realize capital gains to understand their particular situations.
Safe harbors and estimated taxes
Say an investor who makes $80,000 a year bought $10,000 worth of Tesla (TSLA) shares in April when shares were $100 (in today’s post-split values), and sold them in August after the stock rose to $400 for $40,000. They would have netted $30,000 on that trade. But since that’s a short-term capital gain, it means the investor would have to pay ordinary income tax on that money — let’s say around 24%, which comes to around $7,200.
This person’s taxes are $7,200 higher than last year because of the Tesla gain, but there are two main ways to get people into a “safe harbor” situation to avoid penalties that come with underpaying taxes. (A safe harbor is a legal provision to reduce or eliminate a liability, or tax, if certain conditions are met.)