The returns you earn from day trading are taxable, so it’s important to understand how taxes can affect your earnings. In this section, we explain the types of taxes you have to pay on your earnings from day trading and the impact of day trading on the amount of taxes you pay.
DAILY TRADING FEES
The IRS (Inland Revenue Service) identifies shares as capital assets and levies capital gains tax on earnings generated by their for-profit trading.
For example, if you bought a stock for $100 and sold it for $110, you made a gain of $10 per share, on which you’ll have to pay capital gains tax. However, if you sold the same shares for $90, you would have a loss of $10, which is called a capital loss.
The rate of capital gains tax you pay depends on how long you have held the business to generate profit. The IRS charges variable capital gains tax rates of 0%, 15%, or 20% on securities held for more than one year. The higher the holding period, the lower the tax rate charged.
Conversely, if you generate profits on securities held for periods of less than 12 months, you would be charged capital gains tax at your normal rate of income tax. The earnings generated by day trading can increase your income and can push you into a higher tax bracket and, as a result, increase your tax responsibility.
Theoretically, you can be taxed up to 37% for your short-term capital gains, which is the tax charged on the highest ordinary income bracket.
HOW MUCH TAX DO YOU PAY ON DAY TRADING?
Day-trading transactions are reported on IRS Form 8949. However, you should ensure that the transactions on the form match the statement your broker reported on Form 1099-B. Gains or losses shall be calculated on the form in Annex D, which is annexed to Form 1040.
You can reduce your income tax liability if you incur net capital losses. The IRS allows you to deduct capital losses of up to $3,000 from your income if you’re filing individually. The deduction limit is $1,500 if you are married and have jointly filed.
However, you need to understand the rule of washing sale while earning income tax deduction. The rule states that you can’t hold stock within 30 days before or after the holding period for which you’re applying for a tax deduction.
The IRS does not allow the deduction of holding losses for tax purposes on washing sales.
HOW DOES DAY TRADING AFFECT TAXES?
Earnings from day trading and long-term investments are taxed at different rates. If you are involved in day trading, you will be taxed at the same rate as your regular income tax rate. The standard rates of individual income tax in the United States for the year 2021 range from 10% to 37%.
If day trading is your only income, you will be taxed at the rate between 10% and 37%, depending on your income range.