Dear Tax Genius,
I made a lot of money trading GameStop stock earlier this month. When do I need to pay capital gains tax?
— Sidequest Success
Dear Sidequest Success,
First of all, congratulations. Trading on the stock market isn’t usually a safe way to make money, so nicely done. As for capital gains tax on stocks, I would say there are two big considerations: when you sold the stock and how much you earned relative to the rest of your income.
If you sold your GameStop shares in 2021, then you will report that income on your 2021 tax return, which you can’t file until early 2022. In this case, you may not need to worry about your capital gains until next year. Any stock you sold during 2020 is included on your 2020 taxes, which is what you need to file by Tax Day on May 17, 2021, unless you request a filing extension.
BUT (and with taxes, there’s usually a but) if you made a lot from selling GameStop stock, you may need to pay some or all of your taxes sooner to avoid an IRS penalty. If at least 90% of your total income this year comes from an employer who withholds tax from your paychecks, you probably don’t need to worry about underpayment penalties. This covers most people who have a regular job and trade stock as a hobby or side gig. But if you earned significant untaxed income — most stock sales don’t have tax withheld — you may owe much more tax than your employer is withholding. Underpaying your taxes by $1,000 or more can also result in a penalty.
How to avoid tax underpayment penalties
All taxpayers are required to pay their income taxes throughout the year. Employers usually withhold income taxes from employee wages, and your end-of-year tax return allows you to confirm to the IRS how much income you earned and whether or not you already paid enough to cover your tax liability. You will get a tax refund if you overpaid and owe a tax bill if you underpaid. Income from stock sales rarely has tax withheld, but you are still on the hook for tax on investment income.
To ensure that you avoid underpayment penalties, the IRS requires that taxpayers do one of two things:
By the end of the tax year, have prepaid at least 90% of the total income tax you’ll owe for that year.
By the end of the tax year, have prepaid an amount equal to 100% of the total federal income tax you paid last year. This is called the safe harbor rule. (If your income was $150,000 or more last year, the IRS requires that you instead pay an amount worth 110% of last year’s tax amount.)
The IRS advises that you can use whichever option requires you to pay less. So as long as no more than than 10% of your income is from untaxed sources, like stock trades, you're probably all set and can wait until you file next year. But if your income is much higher this year than it was last year, you can avoid a penalty by ensuring you pay an amount of tax equal to all of what you paid last year (or 110% if last year’s income was $150,000 or more.)
Unfortunately, if you think more than 10% of your income will be from untaxed sources, you will need to do some math to approximate how much additional income tax you’ll owe for the year. The IRS’ tax withholding calculator can help you estimate.
What to do if you have an employer
If you have an employer who already withholds payroll taxes, you can avoid underpaying by asking your employer to withhold more tax — enough to cover the extra income you’re earning from untaxed sources. Do this by filling out a new copy of Form W-4. Many employers allow you to fill out a W-4 and submit it online.
Learn more about how to update your W-4.
What to do if you you don’t have an employer
If you don’t have an employer withholding taxes or if you don’t want your employer to know that you’re earning income outside of your main job, you will need to pay estimated taxes.
When considering estimated taxes, make sure to factor in all of your untaxed income. This includes stock dividends, bank interest, income you earned as an independent contractor (such as a ride-share driver), almost all income reported on a 1099, and any other income that has previously required you to pay self-employment tax.
How to pay estimated taxes
Use Form 1040-ES to calculate your estimated taxes. The IRS allows taxfilers to pay estimated taxes through its online portal with either a credit card, debit card, or direct bank transfer. You can also mail a physical check or pay over the phone, if you prefer.
Don't forget to look at state income taxes, too. If your state collects its own income taxes, you likely have to pay both federal and state estimated taxes.
Learn more in our guide to estimated taxes.
Calculating capital gains taxes on stocks
How much of your gains is taxed will depend on your cost basis (or simply basis). Cost basis is the value of your stock and it's usually however much you initially paid for that stock. So if you bought GameStop stock at a price of $50 per share, your basis is $50 for each share. Your ultimate gains are determined as your final sale price minus your basis. If you sell a GameStop share at $250, then you had a capital gain of $200. That $200 is then subject to income tax. If you sold stock at a loss, the losses would actually decrease the amount of overall tax you owe that year.
Also note that unlike regular income, you don’t have to pay Social Security and Medicaid taxes (sometimes called payroll taxes) on your investment income. Other types of investment assets, like cryptocurrency, are taxed the same way. So you would pay taxes on Bitcoin or Dogecoin gains based on the amount reported by your currency exchange.
Capital gains tax rates
If you held the stock for less than one year before selling, profits from your GameStop stock likely qualify as short-term capital gains. Any realized profit from short-term gains is added to the rest of your income and taxed according to the ordinary income tax rates. If you were one of the few diamond-handed investors holding GameStop long before it became a meme, your stock profits may qualify for the long-term capital gains rates, which are much lower. While the maximum tax rate for ordinary income is 37%, the maximum capital gains rate is 20% (and most people only pay up to 15%).
How to include capital gains on your tax return
No matter which type of capital gain you have, you will need to complete some additional tax forms with your federal tax return: Form 8949 allows you to list out the stock you sold, the cost basis of that stock, and your ultimate capital gain (or capital loss). This information is usually reported to you on a 1099-B from your broker. The information on Form 8949 is used to fill in Schedule D, which is where you calculate the capital gains tax you owe. These forms all attach to your main tax form — Form 1040.
Learn more about how to calculate capital gains tax.