What You Need to Know
- The rude awakening faced by some new retail traders at tax time has become a hot topic among advisors.
- One advisor had a client come to him with a 500-page tax form.
- Trading platforms do little to warn investors of tax consequences, Jeffrey Levine says; TD Ameritrade spotlights its investor resources.
Advisor and accountant Dan Herron got a large PDF from one of his clients via email this week.
“It’s from Robinhood, which is pretty common these days,” said Herron, who leads Elemental Wealth Advisors in San Luis Obispo, California. “But when I opened it, I was like, ‘Holy —-!’ Pardon my language. There’s 500-plus pages [to the 1099-B tax form], and … a lot of transactions, a lot of volume, from options trades to individual stock commissions to ETFs.”
This tax season, advisors say investors who traded on Robinhood and other do-it-yourself investment platforms last year are now getting a big shock from the often-overlooked side of investing: lengthy tax documents and potentially huge tax bills.
The platforms “gamify [investing] to where people think it’s just fun, and they’re just trading paper money or whatever,” Herron said. “One of the scary things [DIY investors are] now finding out is that, hey, 1099-Bs are real.”
(Robinhood did not respond to requests for comment about the matter as of press time.)
Herron and other financial professionals have been exchanging their views about these situations on social media recently. Another example, shared by advisor Brian Wruk of Transition Financial Advisors Group in Gilbert, Arizona, was posted to online forums for members of the Financial Planning Association and the National Association of Personal Financial Advisors; it later circulated on Twitter.
In his NAPFA post, Wruk explained that a DIY trader he knows, but is not his client, recently put his 1099-B information into TurboTax and “to his chagrin” had a $1.4 million in capital gains and a tax bill of “just over $800k … he never knew anything about the wash-sale rules.” (The investor traded on the TD Ameritrade platform.)
While the trader started out with $30,000 in his brokerage account, he had some $45 million — “yes, million” — in total trades and a net profit of $45,000, Wruk explains in the post. By trading on margin in 2020, the investor could execute multiple trades that added up to between $200,000 and $2 million some days.
“When it comes time to report those trades on your tax return, you’re going to owe a ton of money — because what you’re seeing … is that it’s all short-term gains,“ said Wruk in an interview with ThinkAdvisor.
“They’re not holding it for investment, so they’re not getting long-term capital gains treatment,” With a lot of wash sales, they’re disallowing a lot of losses. People are ending up owing a significant amount of money.“
Per IRS rules, investors can’t claim losses if they sell and buy the same or very similar securities within 30 days. “You can’t deduct losses from wash sales unless the loss was incurred in the ordinary course of your business as a dealer in stock or securities,” according to the tax agency.
More Investor Troubles to Come
The investor Wruk knows and Herron’s client are not anomalies, other advisors say.
“I would expect to see more of this going forward,” said Jeffrey Levine, lead financial planning nerd at Kitces.com and chief planning officer at Buckingham Wealth Partners, in an interview.
“The fact of the matter is that the rules are complicated and you don’t know what you don’t know,” explained Levine, a CPA and CFP. “Unfortunately, this [situation raised by Wruk] is a case of what you don’t know biting you in the butt after it’s too late. After the year ends, it’s too late to go back and fix these sorts of things.”
Levine agrees that the “gamification” of investing is a factor in these situations. Taxes are “probably the last thing anybody’s thinking about. They’re just having fun … ,” he added.
When asked about the DIY investor’s trading, a TD Ameritrade spokesperson said: “We offer a number of educational resources specific to wash sale rules, including in-platform videos and explainers and publicly available articles on our Ticker Tape blog.”