Personal Finance

Made a killing in GameStop? Now comes the tax bomb

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Key Points
  • GameStop's stock price grew more than 1,700% since the start of the year through Wednesday's close, to almost $348 a share.
  • The federal government and most states tax investment returns.
  • The wealthiest Americans may forfeit almost a quarter of their earnings to federal capital gains taxes, and more than 40% in some cases. Some low earners may pay nothing at all.

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Paul Weaver/SOPA Images/LightRocket via Getty Images

Investors gawking at hefty returns from GameStop stock may be in for a surprise: a big tax bill.

GameStop's stock price has swelled more than 1,700% since the start of the year through Wednesday's close. It rallied 130% on Wednesday to almost $348 a share. The video game retailer's stock cost $39 a share just a week earlier.

AMC and Bed Bath & Beyond stock also surged this week, fueled by extreme speculation among retail traders.

But Uncle Sam will also be profiting from investors' fortunes.

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GameStop buyers who sell their holdings will owe capital gains tax on any earnings. Let's say, for example, an investor sells the stock for a $1,000 profit. That $1,000 is subject to tax. It would come due in the 2021 tax filing season if sold this year in a taxable account.

The total amount will depend on many things, including an investor's income and the period of time the investor owned the stock.

The wealthiest taxpayers will give up almost a quarter of their earnings, at a minimum, and possibly more than 40% to the federal government. States may take even more.

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Of course, investors may choose to hold their investment, in which case they wouldn't owe tax.

Those who sell for a gain — and pay the taxman — can still take comfort that they ultimately made money.

"If you've had a really great run, there's always an easy way to avoid paying tax — and that's losing all your money," said certified financial planner Jeffrey Levine, chief planning officer at Buckingham Wealth Partners on Long Island, New York. "Having most of something is always better than all of nothing."

Long-term capital gains

The federal government taxes long-term capital gains (those from an investment held more than a year) at favorable rates relative to typical income taxes.

For example, the wealthiest Americans pay a 23.8% top tax rate on these stock returns (a 20% capital gains tax plus a 3.8% Medicare surtax on investment income). However, they pay a 37% top rate on wages.

Low and middle earners may pay a smaller share — 15% or possibly nothing at all, depending on their annual taxable income.

Short-term capital gains

But the bite would be larger for those who sell stock after just a brief ownership.

They would pay short-term capital gains rates, which apply for investors who sell a stock after a year or less. They are the same as one's personal income tax rates.  

Uncle Sam would take 40.8% of the wealthiest investors' GameStop earnings in this case, instead of 23.8%. (This includes a 37% top income tax rate and a 3.8% Medicare surtax.)

Most states tax capital gains as ordinary income — meaning long-term investors don't get a favorable tax rate.

Tax-loss harvesting

Investors may be able to limit their tax bill using a strategy called "tax-loss harvesting."

Investors would deliberately incur losses in a taxable account by selling off investments that have fallen in value. By doing so, investors can offset capital gains from appreciated assets that they've sold.

However, there are caveats and potential traps for the unwary.