Minimize Short Term Capital Gains & Day Trading

To reduce your Federal and State income tax obligations, strive to minimize or even eliminate short-term capital gains and day trading activities in securities and other capital investments. Such activities occur most often with investments in certain tech stocks, “meme” stocks, call and put options, and cryptocurrencies.

On your Federal tax return, short-term capital gains are taxed at ordinary rates, as detailed in Tax Brackets and Tax Rates, all the way up to the highest rate of 37%. Congress has proposed legislation to increase this rate during 2021 or 2022. In addition, short-term capital gains are subject to a Federal Net Investment Income Tax (NIIT) surtax of up to 3.8% as calculated on Form 8960.

On your Massachusetts tax return, short-term capital gains are taxed at the rate of 12%, as calculated on MA Schedule B. MA DOR loves day traders!

The State of New Hampshire does not levy any personal income tax on short-term or long-term capital gains income.

Let’s consider a couple of trading scenarios:

1. Suppose that you earned $100,000 from your trading activities during the year. That’s awesome! Good for you.

   However, your trading activities resulted in short-term capital gains, meaning that all such income will be taxed at ordinary rates. This income from trading will likely push you into the 37% Federal tax bracket (the highest bracket). You will have to pay the IRS $37,000 in income taxes on your trading gains, plus a Net Investment Income Tax (NIIT) surtax of up to 3.8% or $3,800 as calculated on Form 8960. So, $40,800 (= $37,000 + $3,800) to be paid to the IRS.

   Massachusetts residents will have to pay MA DOR a short-term capital gains income tax of 12% or $12,000 in MA income taxes, as calculated on MA Schedule B.

   Combined, you will pay a total of $52,800 in Federal and MA income taxes. Ouch! Leaving you with just $47,200 after you’ve satisfied your Federal and MA income tax obligations.

   New Hampshire residents would not pay any short-term capital gains State income tax.

   Most traders do not set aside cash received from the securities sold to cover their current income tax liabilities. Instead, they reinvest that cash in additional trading activities. In April, when I inform these clients of the amounts Federal and MA income taxes that they owe from the prior year, they must scramble to sell some additional positions to generate the cash needed to cover their prior year's income tax liabilities. This often results in sudden, unplanned losses on these immediate trades, or at best, additional short-term capital gains income taxable in the current year. This cycle repeats itself.

2. Lets’ go in the opposite direction. Suppose that you lost $100,000 from your trading activity during the year. Ouch! I’m sorry to hear that. IRS regulations allow you to:
   1. Utilize such losses to offset other short-term and long-term capital gains that you realized during the year, and
   2. Deduct only $3,000 (yes, just $3,000) of capital losses on Schedule D of your Form 1040 return each year. At this minimal rate, it would take some 33.3 years to use up all such losses on your Federal returns.

      Massachusetts DOR regulations regarding the deductibility of capital losses are even more stringent than those of the IRS.

      If you happen pass away during this period, any remaining unused capital losses cannot be utilized or passed down to your children or other heirs. They will simply disappear entirely.

Trading is a difficult and time-consuming endeavor. In my opinion, it is best to leave trading activities to professional investment advisors.