Pandemic Day Trading is not all Glitz, Glamour and Easy Money

The volatile pandemic stock market has drawn new day traders into its seductive embrace by the millions. Tney are mesmerized and ncentivized by no-commission trades, boredom in lockdown, and by a phoenix-like recovery from the depths of the March 2020 stock market debacle.

The volatile pandemic stock market has drawn new day traders into its seductive embrace by the millions. They are mesmerized and incentivized by no-commission trades, boredom in lockdown, and by a phoenix-like recovery from the depths of the March 2020 stock market debacle. Along with the glitz and glamour, many new traders are learning important lessons. WATCH THE VIDEO

Hard Lessons

Hard Lesson #1: Markets don’t always go up.

Hard Lesson #2: Each non-retirement account transaction is likely a taxable event, and in the case of successful traders, Uncle Grabby’s IRS is waiting for its cut.

In short, a day trading enthusiast must not only be a “savvy” trader, but an individual knowledgeable in certain provisions of the U.S. Internal Revenue Code, as well. Did I hear you ask why?

Taxable Gains & Losses

Well, here’s why. When trading in taxable accounts, each trade is likely to generate either a taxable gain or a loss that can offset a taxable gain if one exists. Those off-setting losses can be particularly important, and, yes, they do happen. The “savvy” investor will quickly learn to optimize after-tax profits by timing when to sell both winners and losers – or by selling one lot of a particular company’s shares instead of another lot. We’ll talk more about “lot selling” later. First, some fundamentals.

Year-End Results

As a “silent partner”, Uncle Grabby is not particularly interested in how much you gain or lose on a specific transaction. Rather, he wants to know the net result of your total transactions at year’s end.

Arriving at that number begins with figuring the gain or loss on a specific sale by subtracting the asset’s purchase price (plus odds and ends) from the sales price. The net is your gain or loss on the sum total of those transactions. Logically, if a trader’s gains exceed losses, a capital gains tax is owed. If losses exceed gains, no tax is due.

Credit For Losses

Because Uncle Grabby is a generous old dude, in the case of a net loss he will allow you to deduct up to $3,000 against ordinary income earned in that same year. Sad to say, not infrequently day traders’ annual capital losses exceed $3,000 in which case they can carry forward the excess to first offset capital gains and then up to $3,000 of ordinary income in future years until the losses are exhausted.

22% Tax Rate

Day traders usually aren’t eligible for the lower tax rates that apply to long-term capital gains – investments held for longer than one year. Long-term capital gains tax rates are 0%, 15%, and 20% depending on an individual’s income. The net profit of a day trader’s transaction is typically short-term in nature and taxable at the higher rates used for ordinary income… often 22% or more. This is an important distinction when deciding to sell shares of the same stock bought at different times and prices.

To minimize taxes, it makes sense to sell the stock with the least capital gain considering both the net margin (gain or loss) and whether or not it is short- or long-term. Of note, should the investor not specify which lot of a particular stock is sold, the default movement from inventory is typically first-in, first-out (FIFO).

Trader Tax Break

Thanks to Obamacare, there is a 3.8% surtax on net investment income above certain earnings thresholds, and some states have high income tax rates and offer no reduced rates for capital gains. Countering those tax considerations is a tax break available to some day traders who claim that trading is their business – not a sideline gig – and are able to deduct certain expenses (home office and related expenses, computers, tax preparation, etc.) on Schedule C of their tax return. Uncle Grabby’s requirements to gain these benefits are rigorous, involving certain numbers of trades per year and hours of trading per day and week.

Not Easy Money

Although the current volatile market and ease of entry has gained the attention of millions of folks, it’s probably not for the uninitiated and it’s not easy money. Markets do fluctuate, and to be sure, Uncle Grabby is a most willing participant in sharing your winnings. So be aware of the tax angle.

Because I am a persistent and conservative index fund investor, I will again remind my audience of another approach… the PDQ Principles of investing – an approach built around index fund investing that involves purchasing (on a dollar-cost average basis) low-cost, highly diversified, quality products and then exercising a boat-load of patience while letting the Amazing Power of Compounding work its magic.

Be diligent in your trading and good luck.