Robinhood Trader May Face $800k Tax Bill | Hacker News Reader

Robinhood Trader May Face $800k Tax Bill

forbes.com

47 pointsrmason45 comments

HFT trader here. I’ve commented on this story in another context, but I’m virtually certain there’s an error with how Robinhood is calculating wash sale adjustments.

First, it is true that you can’t deduct a capital loss if you buy the security back in 30 days. However that loss does rolll into an adjustment on the cost basis of the next trade you make in the security. So as long you have a net trading profit on the stock over the year, then you don’t incur any additional tax liability.

Really the only way to get screwed by the wash sale rule is if you’re making a net loss on a specific security. This might be common in a high frequency pairs trading strategy. Say you make $10 million net profit trading stock A but lose $9 million trading stock B because you use it as a hedge. In this case you genuinely would be stuck with a $10 million tax liability despite only making $1 million in actual profit.

However in this case, I really doubt that’s what happened. The IRS rules on wash sales were written in a bygone era when high frequency trading didn’t exist. The rules are very poorly worded and hard to interpret.

> but I’m virtually certain there’s an error with how Robinhood is calculating wash sale adjustments.

Or, maybe it could be turbo tax importing the wrong info? IIRC they did not import the cost basis from employee purchase plan sales in my ETRADE account one year and treated it as a cost basis of 0. The trader in the article definitely needs to hire a CPA.

This is a well-known issue with TurboTax and how it imports ESPP cost basis. The same happens with Fidelity reports as well.

But in this case, the scale (number of trades) seems to indicate this was a day trader who was frequently moving in and out of the same (or substantially similar) positions and hence not related to ESPP.

Right, it's a totally different error, just mentioned it to illustrate that just importing your brokerage account into Turbo Tax (what the article purports the Trader did) doesn't work 100% of the time. In this case I'm not sure if it's Turbo Tax or Robinhood calculating the cost basis after wash sales, just mentioning it could be another edge case where Turbo Tax is messing it up.

I've wasted so much time with turbotax this year I'm thinking next year to either use some other tool and do everything manually or hire a CPA.

Here's one thing I had a problem with this year - Turbotax incorrectly computed gains/losses for all my accounts because it started rounding cost basis and proceeds of _every separate transaction_ to the nearest dollar, accumulating the dollar. I can't fathom why the software even bothers with any intermediate rounding. Big thread [here](https://ttlc.intuit.com/community/investments-and-rental-pro...).

For the record, other tax software does this type of rounding too. Unless you have really small lots, it shouldn't make a big difference, and I wouldn't worry about it.

If you do have small lots, you can consider doing the summary method using Exception 1 (if eligible) or Exception 2 otherwise. https://www.irs.gov/instructions/i8949#idm140393400814208

Note that Exception 2 requires an attached statement (generally, your copy of the 1099-B). From what I've heard, some tax software supports PDF attachments, but others, like TurboTax, make you print and mail.

As long as you don't make a wash sale between a purchase in an IRA (or maybe 401k) and a sale in taxable, the disallowed loss (as well as the holding period) is added to the cost basis of the replacement purchase.

This delays recognizing the loss, and maybe you end up with a big gain in one year and a big loss in the next year, but you only really get screwed in the IRA case where the loss is disallowed in the taxable account and the basis isn't adjusted in the IRA; in that cass, the loss just evaporates.

I think it’s a little nuanced than that. In your example if trade activity is ceased 30 days prior to tax reporting then the tax liability is only $1M. If stock B got stuck in the wash rule then you are on the hook for the complete $10M. Then the difference becomes business loss vs personal loss. On your personal taxes you cannot deduct that $9M liability all at once unless you have other capital gains to cover it. you can roll it forward a few years but that’s a massive loss most will likely never be able to gain from. Businesses can deduct 100% of losses against taxable income with the potential of triggering an audit at certain thresholds

This is my poor understanding of wash sale rules wrt the IRS

Btw, what tripped me up recently is that I misunderstood the "buy the security back within 30 days" part and was quite confused why my broker was showing me a wash sale:

I did something like:

  * Day 1: Buy 100 shares of Stock A at $100
  * Day 2: Buy 100 shares of Stock A at $110
  * Day 3: Sell 100 shares of Stock A at $90 (using most recent lot for cost basis)

Result: The loss of $10*100 on Day 3 is disallowed because the sale was _within_ 30 days of the last stock purchase. I failed to realize that it would apply to a period of 30 days both before and after a transaction, always thought the only way to trigger a wash sale is with a Buy.

It's utter bullshit to say he has that tax bill on a net profit of $45k. That's not how the wash sale rule works. The only way he could end up in that situation is if he ended the year holding positions with $2M in unrealized losses.

Also, $1.4M in gains but $800K in taxes? Even California doesn't tax like that.

I'm not sure if it's more charitable to assume the article is intentional lies for page views or finance reporters who know nothing about the industry they supposedly cover.

It's FUD from Citadel trying to stir up mistrust in retail traders.

1. You shouldn't have any trust in RobinHood to begin with - not because they behave illegally or maliciously, but because they often behave incompetently. If you're going to day-trade, use a better exchange - one that's not ran like a circus.

2. The Citadel/Melvin/Reptilian wrecker, saboteur, and boogieman as the source of all unexplained events, price movements, and news is a ridiculous, unsubstantiated meme.

That seems completely unfounded. Citadel benefits from payment for order flow from retail traders. They do not gain by scaring them away.

NYC? In NY state, once you hit the top bracket at 1.1M, it's a flat rate applied to all income, not a marginal rate. Then you have the 3.8% Obamacare surtax on investments.

It boggles my mind that someone making 10-50 trades _per day_ with a trading volume of $200,000 and $2 million _per day_ is doing so using Robinhood.

Yes, Robinhood is an easy app to use.

But at that volume, you really should be using a legitimate trading platform with fully built out functionality designed for people trading with that kind of volume.

I want to blame Robinhood for this (and I think they should obviously fix issues such as selling shares on a First In First Out basis, which isn't always optimal for tax purposes) but I can't blame Robinhood fully for this.

If you're going to play the game at a professional level it's kind of your responsibility to know the rules and to pick the right tools for the job. Robinhood is clearly not built for people trading millions of dollars per day.

>a legitimate trading platform with fully built out functionality designed for people trading with that kind of volume

Note that many people have no reason to believe that Robinhood does not match this description (even I only assume it doesn't, but that's only based on perception, not anything remotely objective - I can't trade in quantities above 3 or 4 digits, so I don't feel the need to invest my time in learning the differences between Robinhood and more "legitimate" platforms).

Like you say, they do have a responsibility to learn such things, once they are trading in such volume, but Robinhood also creates zero barrier to entry, and knowing what you don't know is a real skill, and with those two facts, we do have to be thoughtful about precisely where we lay blame.

> Note that many people have no reason to believe that Robinhood does not match this description

I disagree with this. To me, it's like saying "I build websites using Squarespace WYSIWYG, but I'm unaware that there are a whole lot of engineers out there building websites with code."

Anyone trading millions of dollars a day is aware of platforms like thinkorswim which alone shows how limited Robinhood is.

Some use robinhood for trades but use other software for charts. It's convenient and fast enough.

How is it possible for the tax liability to exceed the profit? The article mentions wash sales, but it doesn't explain what sequence of such trades can cause this situation.

You buy security X for $1000 and sell it for $100. You immediately repurchase security X for $100 and sell it for $1100.

You made a net profit of $100 but are taxed on $1000 because you can't write off the $900 loss.

This is not how it works under the wash sale rule. In your example, the $900 loss would be added to the cost base when doing the second purchase. Because of that, the sell at $1100 will have a cost base of $1000.

The loss of the wash sale is added to the basis of the next purchase. You would still be taxed on a gain of $100 in that scenario.

The nasty case is if you buy X at $100, sell at $1000, buy at $1000, wash sell at $100, then buy at $100.

You have $900 in gains according to the wash sale rule but no actual gains. Your basis in X is $1000, so you would have no gain if you sold at the current price, but if you hold it until the end of the tax year, then you owe taxes on $900 despite not making anything.

Would it be safer to close out out potential wash-sale positions by end of November, instead of end of year?

I imagine a situation where you sell everything of Stock A on Dec 20 realizing all losses, and then mistakenly rebuy back on Jan 10. Now all your loss for previous year is disallowed and you have no way to fix it? Even if you immediately sell the loss would count for the current tax year, and not previous tax year, right?

There is a "Wash sale" rule that prohibits writing off losses on stocks purchased within 31 days of their sale, but they don't apply to day traders.

https://www.irs.gov/taxtopics/tc429

He will need a good CPA to declare which assets were long term investments and which fall under mark-to-market day trading rules, but he won't need to pay $800k.

tl;dr: clickbait (mostly), but do read up on the wash-sale rule if you intend on day trading in order to save yourself an end of year headache.

My understanding is that he can still count these losses towards the cost basis of the stocks, so it's not like the money is gone - just absorbed into the capital gains that will be calculated when he does sell. And if he had sold these >= 30 days before the end of the year, he would have been able to claim the losses on this year's taxes.

Edit: all that to say, I agree that it's clickbait.

What this difference in tax aims to achieve? It seems like it is so complex it reminds me of parking meters with confusing signage designed to trap people not familiar with the area. Was that lobbied by existing traders to gatekeep their cake?

The wash trade rule is to prevent people from taking a loss at the last day of the tax year to offset gains in other securities. Then re-buying it on the first day of the next tax year to "reset" the cost basis. In short, it's to prevent tax evasion shenanigans. Tax law is complex because people will spend a lot of effort to find loopholes. Closing these loopholes one after another creates the complexity.

But why shouldn't you be able to take your losses at the end of the year if you so choose?

It makes no sense.

You can, but if you buy back the next day on the new year (and the price didn't move) you didn't actually take a realized loss.

How do you take a loss? Do you organise a press conference and then tell the media that the company you have shares of is bad? Wait for the shares to tank, sell. When the new tax year comes, buy all the shares and then organise press conference again to say sorry and it was just a prank?

> How do you take a loss?

Portfolio of a hundred names. Half went up, half went down. Sell the downs on 31 December and buy back in 1 January (spherical cow). On the off change nothing in your portfolio lost money, congratulations. Also you don’t get this.

Right, so you don't actually have a control over making loses at the end of tax year and if you buy back, there is no guarantee the stock will ever go up. So what is the issue?

You didn't actually have a loss that year (to offset gains)

Under (default) investor rules, you recognize income (or losses) only on sales or dividends (or taxable reorganizations), and can get long term capital gains, have a low limit on offsetting losses against ordinary income, can carry forward excess losses forever, and have the wash sale rule.

Under trader rules, you must recognize gains (or losses) at the end of each year, and don't get capital gains rates, but you can offset income with losses all the way to $0, loss carryforward is time limited, but you can also carry back a few years.

I'll keep my tax deferral and long term capital gains rates, thanks; but if I were a frequent trader, it seems like the alternate regime is simpler.

I've read 10 or 20 books on trading and investing and never heard it explained like this. Thanks.

This is not correct. Wash sale rules apply unless you make a mark-to-market election in the prior year.

true about the mark-to-market specific election, it does need to be done the year prior and makes things for the following year earlier. He will still get out of the tax bill though through documentation.

> A trader must keep detailed records to distinguish the securities held for investment from the securities in the trading business. The securities held for investment must be identified as such in the trader's records on the day he or she acquires them (for example, by holding them in a separate brokerage account).

Except for the first year in business, you can make that selection at the tax time of current taxes.

EDIT: I am wrong: https://www.optionstaxguy.com/mark-to-market

> but they don't apply to day traders

How does this work for bot trading? Is that considered day trading?

Crypto bots are popular. When you trade cryptocurrency for another crypto, you are taxed on the value at which you sold it in USD, net the amount for which you purchased it in USD.

Would this be done mark-to-market?

I'd imagine a lot of traders thinking they can easily plug in the latest bot into their Binance account are in for a surprise when they see the size of the return they have to file.

I'm only talking about the US regulation here.

Wash sale rules (the problem here) don't apply to crypto because it's considered property and wash sales only apply to "stocks and securities". You can definitely get into trouble if you do something like sell at a gain at the end of the year and instantly lose it all though.

Slight off topic but how does one find a good CPA when they don't have access to trusted referrals?

These financial sites and their dumb tax bill scares. Its complete and utter nonsense. I remember after the gamestock share price run up there was scaremongering about enormous tax bills in cnbc and other sites like retail investors making a little money is so bad.

Robinhood working as intended. They got tons of engagement from the user, sold that data to Citadel, and the end-user is left footing the tax bill. Is that cool? No. Is it fair? No. Should this be allowed? Nope.

But it's working as intended.

If a user uses $1M of his own money to trade and make 100K in profit. Does he owe taxes on 100K or 1.1m?

On $100K.

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