What Robinhood Traders Need to Know About Taxes
What Robinhood Traders Need to Know About Taxes
What Robinhood Traders Need to Know About Taxes
President Biden entered office with an ambitious agenda. From expanded healthcare subsidies and increased social security benefits, to student loan forgiveness. This would be costly. As a candidate, Biden proposed a series of tax rate increases on high-income families to pay for some of his new programs. Under his plan, corporate income tax rates and top personal income rates would rise. Top earners would face new Social Security taxes, and millionaires would face much higher tax rates on capital gains and dividends. What would these tax rate hikes look like, and what would they do to the economy?
Until 2018, the US had the highest statutory corporate tax rate in the developed world. Even before accounting for new state taxes, the top rate was 35%. This was well above rates in Ireland (12.5%), Canada (15%), and the UK (19%). The Tax Cuts and Jobs Act of 2017 (TCJA) permanently lowered the top rate to 21%. The current administration wants to increase the rate to 28%, which is higher than most developed countries, but still 20% lower than the 2017 rate. There are some reasons for why there isn’t support for the old rate:
Slower economic growth and lower wages are a high price to pay for a tax that yields surprisingly little revenue. It’s no wonder then that there isn’t much support for pushing the rate back up to its former level.
About half of all federal tax revenue comes from personal income taxes. These taxes are progressive, meaning that as your taxable income rises, the share of your taxed income rises too. Every dollar of taxable income is taxed at a particular rate, called a marginal tax rate. Currently, marginal tax rates on earned income range from 10% to 37%. President Biden wants to raise the top rate to 39.6%, the rate that existed prior to the TCJA.
The personal income tax code doesn’t just tax wage income. People also pay income tax on realized capital gains and dividend payments. Capital gains are the profits made form selling an asset for more than it was bought. The tax rates for investment depend on the gross income of the tax filer and how long the filer held the investment. If you sell an asset within a year after buying it, your tax rate is generally the same tax rate you pay on your taxes. If you held it for more than a year, you pay a lower tax rate. Biden’s plan calls for eliminating this lower tax rate for filers with incomes above $1 million. How big of a tax increase would this be? Currently, the top rate on long-term capital gains and qualified dividends is 23.8% Biden’s plan calls for this to rise to 43.4%.
These higher marginal tax rates would have significant effects on the economy. Watch this video for an explanation:
The marginal tax rate affects a person’s decision on whether to work more hours, hire more workers, or invest in new innovations or businesses. As the video explains, the “investments not made, schooling not pursued, or businesses not started all cumulatively add up to a lower quality of life for everyone.”
While high marginal tax rates discourage the behaviors that produce economic growth, many policy makers are willing to accept that outcome in order to make the tax system more progressive. They argue that high-income taxpayers can afford to pay more. But just because they can, doesn’t mean they will. As we saw with corporate income taxes, the higher the rate, the more incentives people have to avoid the tax. This will be done either through clever accounting or through changing their economic decisions.
Further, the US already has one of the most progressive income tax systems in the developed world. The progressive rates don’t necessarily yield substantially higher tax revenue. The tax code is filled with countless deductions that reduce a filer’s taxable income and tax credits that directly reduce a filer’s tax liability. Filers may cut their taxable income by deducting charitable contributions, the interest they pay on their mortgage, and taxes they pay to state and local governments. Families with children may reduce their tax bill by claiming the child tax credit. Businesses can claim credits for research and development or building low-income housing. The US tax code has long been filled with these types of tax breaks. Milton Friedman explains how these tax breaks interact with high tax rates:
Social Security and parts of Medicare are financed through payroll taxes on wage and salary income. The 2.9% Medicare tax, split evenly between employee and employer, is assessed on all wage and salary income. The Social Security tax is more complicated. It assesses a 12.4% tax, split like Medicare, on earnings up to the so-called taxable maximum. This maximum is set at $142,800 in 2021. Earnings above the taxable maximum face no Social Security taxes. President Biden wants to assess the full Social Security tax on all earnings above $400K.
It might seem odd that top earners pay a lower share of their income in Social Security taxes than those with earnings below the taxable maximum. There is an interesting historical reason for this unique tax. Workers’ taxable Social Security earnings are used to determine how much they receive in benefits when they retire. In discussing Senator Warren’s Social Security plan, John Cogan explains how applying these taxes to earnings above the taxable maximum would alter the nature of the program:
“The cornerstone of FDR’s Social Security program is its “earned right” principle, under which benefits are earned through payroll-tax contributions. Although Congress has eroded this principle over the years, it remains part of the program’s core. Warren’s plan calls for additional taxes on wage earnings, capital gains, and dividends paid to those with high annual incomes. These incomes are $250K or more for individuals, and $400K or more for families. But in a major break from one of FDR’s main Social Security principles, the plan provides no additional benefits in return for the new taxes. Warren’s new tax plan would account for about a quarter of future revenues flowing into the Social Security system. Such a large revenue stream to fund unearned benefits, called “gratuities” in FDR’s era, would put Social Security on a road to becoming a welfare program.
Even beyond its effect on the Social Security program, adding the Social Security tax on earnings above $400K would represent a dramatic marginal tax rate increase. Currently, workers with incomes in the top personal income tax bracket face a marginal tax rate of roughly 40.8%. 37% of that is for personal income taxes and 3.8% for Medicare. Adding the 12.4% tax would raise the top marginal tax rate above 50%, and that is before accounting for state income taxes. Like other marginal tax rates, these high rates will affect decisions to work, ultimately hurting future economic growth.
High marginal tax rates damage the economy and will result in fewer economic opportunities for everyone. yet we need revenue to pay for essential government services, and much more to fund the reforms envisioned by the new administration. Is there a better way?
Fortunately, yes. A consumption tax such as a sales tax or value-added tax offers a far more efficient way to raise revenue. In Blueprint for America, Michael Boskin explains:
“There is considerable research showing that moving toward a broad-based, integrated progressive consumption tax would significantly increase real GDP and future wages. Replacing both the corporate and personal income taxes with a broad, revenue-neutral consumption or consumed income tax would produce even larger gains.”
A consumption tax would give workers, entrepreneurs, and innovators better incentives to work, invest, and create. The result would be an economy that delivers more economic opportunity while providing adequate revenue for the government.
To help you make sure that you do not miss any important 2021 deadlines, we have provided this summary of when various tax-related forms, payments and other actions are due. Please review the calendar and let us know if you have any questions about the deadlines or if you would like assistance in meeting them.
|February 1||Businesses: Providing Form 1098, Form 1099-MISC (except for those that have a February 16 deadline), Form 1099-NEC and Form W-2G to recipients.
Employers: Providing 2020 Form W-2 to employees. Reporting income tax withholding and FICA taxes for fourth quarter 2020 (Form 941). Filing an annual return of federal unemployment taxes (Form 940) and paying any tax due.
Employers: Filing 2020 Form W-2 (Copy A) and transmittal Form W-3 with the Social Security Administration.
|March 15||Calendar-year S corporations: Filing a 2020 income tax return (Form 1120S) or filing for an automatic six-month extension (Form 7004) and paying any tax due.
Calendar-year partnerships: Filing a 2020 income tax return (Form 1065 or Form 1065-B) or requesting an automatic six-month extension (Form 7004).
|April 15||Individuals: Filing a 2020 income tax return (Form 1040 or Form 1040-SR) or filing for an automatic six-month extension (Form 4868) and paying any tax due. (See June 15 for an exception for certain taxpayers.)
Individuals: Paying the first installment of 2021 estimated taxes, if not paying income tax through withholding (Form 1040-ES).
Individuals: Making 2020 contributions to a traditional IRA or Roth IRA (even if a 2020 income tax return extension is filed).
Individuals: Making 2020 contributions to a SEP or certain other retirement plans (unless a 2020 income tax return extension is filed).
Individuals: Filing a 2020 gift tax return (Form 709) or filing for an automatic six-month extension (Form 8892) and paying any gift tax due. Filing for an automatic six-month extension (Form 4868) to extend both Form 1040 and, if no gift tax is due, Form 709.
Household employers: Filing Schedule H, if wages paid equal $2,200 or more in 2020 and Form 1040 is not required to be filed. For those filing Form 1040, Schedule H is to be submitted with the return and is thus extended to the due date of the return.
Trusts and estates: Filing an income tax return for the 2020 calendar year (Form 1041) or filing for an automatic five-and-a-half month extension to October 1 (Form 7004) and paying any income tax due.
Calendar-year C corporations: Filing a 2020 income tax return (Form 1120) or filing for an automatic six-month extension (Form 7004) and paying any tax due.
Calendar-year corporations: Paying the first installment of 2021 estimated income taxes.
|April 30||Employers: Reporting income tax withholding and FICA taxes for first quarter 2021 (Form 941) and paying any tax due.|
|May 17||Exempt organizations: Filing a 2020 calendar-year information return (Form 990, Form 990-EZ or Form 990-PF) or filing for an automatic six-month extension (Form 8868) and paying any tax due.
Small exempt organizations (with gross receipts normally of $50,000 or less): Filing a 2020 e-Postcard (Form 990-N), if not filing Form 990 or Form 990-EZ.
|June 15||Individuals: Filing a 2020 individual income tax return (Form 1040 or Form 1040-SR) or filing for a four-month extension (Form 4868) and paying any tax and interest due, if you live outside the United States.
Individuals: Paying the second installment of 2021 estimated taxes, if not paying income tax through withholding (Form 1040-ES).
Calendar-year corporations: Paying the second installment of 2021 estimated income taxes.
|August 2||Employers: Reporting income tax withholding and FICA taxes for second quarter 2021 (Form 941) and paying any tax due.
Employers: Filing a 2020 calendar-year retirement plan report (Form 5500 or Form 5500-EZ) or requesting an extension.
|September 15||Individuals: Paying the third installment of 2021 estimated taxes, if not paying income tax through withholding (Form 1040-ES).
Calendar-year corporations: Paying the third installment of 2021 estimated income taxes.
Calendar-year S corporations: Filing a 2020 income tax return (Form 1120S) and paying any tax, interest and penalties due, if an automatic six-month extension was filed.
Calendar-year S corporations: Making contributions for 2020 to certain employer-sponsored retirement plans, if an automatic six-month extension was filed.
Calendar-year partnerships: Filing a 2020 income tax return (Form 1065 or Form 1065-B), if an automatic six-month extension was filed.
|October 1||Trusts and estates: Filing an income tax return for the 2020 calendar year (Form 1041) and paying any tax, interest and penalties due, if an automatic five-and-a-half-month extension was filed.
Employers: Establishing a SIMPLE or a Safe-Harbor 401(k) plan for 2020, except in certain circumstances.
|October 15||Individuals: Filing a 2020 income tax return (Form 1040 or Form 1040-SR) and paying any tax, interest and penalties due, if an automatic six-month extension was filed (or if an automatic four-month extension was filed by a taxpayer living outside the United States).
Individuals: Making contributions for 2020 to certain existing retirement plans or establishing and contributing to a SEP for 2020, if an automatic six-month extension was filed.
Individuals: Filing a 2020 gift tax return (Form 709) and paying any tax, interest and penalties due, if an automatic six-month extension was filed.
Calendar-year C corporations: Filing a 2020 income tax return (Form 1120) and paying any tax, interest and penalties due, if an automatic six-month extension was filed.
Calendar-year C corporations: Making contributions for 2020 to certain employer-sponsored retirement plans, if an automatic six-month extension was filed.
|November 1||Employers: Reporting income tax withholding and FICA taxes for third quarter 2021 (Form 941) and paying any tax due.|
|November 15||Exempt organizations: Filing a 2020 calendar-year information return (Form 990, Form 990-EZ or Form 990-PF) and paying any tax, interest and penalties due, if a six-month extension was previously filed.|
|December 15||Calendar-year corporations: Paying the fourth installment of 2021 estimated income taxes.|
|December 31||Employers: Establishing a retirement plan for 2021 (generally other than a SIMPLE, a Safe-Harbor 401(k) or a SEP).|
The Internal Revenue Service (IRS) recently issued Revenue Ruling 2020-27 which provides that expenses paid with Paycheck Protection Program (PPP) loan proceeds are not deductible in the tax year paid or incurred, if at the end of the tax year the taxpayer has a “reasonable expectation of forgiveness.” As a result, many calendar-year taxpayers that received a PPP loan will have additional income to report on their 2020 tax return if they wish to be in accord with IRS guidance.
The IRS states in Rev. Rul. 2020-27 that a taxpayer has a reasonable expectation of forgiveness if he/she intends to apply for loan forgiveness. Therefore, unless a taxpayer has decided not to file for loan forgiveness, the taxpayer is presumed to have a reasonable expectation of forgiveness.
Subsequent to the IRS’s ruling, several members of Congress have expressed concern with the IRS’s position and have made it clear that the congressional intent in the CARES Act was to ensure that PPP loan recipients whose loans are forgiven are not required to treat the proceeds as taxable income. Thus, they are strongly encouraging the IRS to reconsider its position on the deductibility of these expenses, and the timing of those deductions, to provide relief to the small businesses that need it most. In addition, there may be state income tax implications as many states have not conformed to the federal government’s tax treatment of PPP loans or related forgiveness.
Although there is a possibility that congressional action could reverse the IRS position, its likelihood remains uncertain. Given the potential of penalties for underpayment of estimated tax because of the disallowance of the related expenses, our firm believes impacted taxpayers should take proactive action. In order to avoid underpayment of estimated tax penalties, taxpayers should increase their withholding or estimated tax payments to satisfy the prior-year tax safe harbor rules (100% / 110% of 2019).
If you have applied, intend to apply, or are undecided as to whether to apply for PPP loan forgiveness, then, absent further guidance, you should consider the following options for the filing of your 2020 federal income tax return:
1. Extend your tax return to allow additional time for congressional action in opposition to the IRS position.
2. File your tax return based on Notice 2020-32 and Revenue Ruling 2020-27 guidance by NOT deducting expenses paid with forgiven PPP loan proceeds. If the current IRS position is reversed, you can file an amended return to claim these deductions.
3. File your tax return taking a deduction for expenses but disclose (i.e., file IRS Form 8275) a position that is contrary to current IRS guidance. Disclosure helps to avoid the imposition of penalties if the IRS ultimately disagrees with the position but likely increases the taxing authority’s scrutiny of your return.
4. Choose not to apply for the PPP loan forgiveness and deduct the expenses as usual.
Immediate Action Required
Given the uncertainty that exists with the conflict between the current tax guidance as promulgated by the IRS and the congressional intent of the PPP, we strongly encourage you to reach out to us as soon as possible for some tax planning guidance to help minimize your risk for the potential underpayment of estimated tax penalties because of the disallowance of the related PPP expenses. Again, to avoid underpayment of estimated tax penalties, you may need to increase your estimated tax payments for the 2020 tax year as soon as possible to satisfy the prior-year tax safe harbor rules.
If you have any questions regarding this communication or if you need assistance in determining the impact of these rules to your specific tax situation, please contact us. We recognize that these are difficult and uncertain times, and we remain committed to supporting you.