Common tax-minimizing strategies are difficult or impossible to implement on the trading platforms that have boomed in popularity in the past year
Last year Dayton Leong, an active trader with accounts at nine firms, made scores of trades using the Robinhood app. He liked the free stocks he got from referring more than a dozen friends and found it easy to trade on his phone.
Recently, however, he has stopped trading in his Robinhood account, which has about $238,000 in it, mostly in Tesla stock. He says a major reason is taxes.
“Robinhood puts all shares of a stock into one big bucket,” says Mr. Leong, age 43, who lives in Berkeley Heights, N.J., and also works as a property manager. “I’m haunted by my 2020 capital-gains tax.”
With 2020 tax bills coming due, a wave of new retail traders are waking up to the fact that it can be difficult, and often impossible, to make tax-minimizing moves on new brokerage platforms such as Robinhood, Webull, SoFi, Uphold and Public.com. Some don’t allow trading within tax-favored retirement accounts such as IRAs. Traders can also find it hard to track their “wash sales” that reduce tax benefits if they buy a stock within 30 days of selling the same stock at a loss.
Most vexing for investors like Mr. Leong is that despite the new platforms’ sophisticated technology they don’t make it easy to deploy a tax-wise technique known as “specific-lot identification.” Investors use it to lower their taxes, sometimes significantly, by choosing which shares to sell if they have lots bought at different prices and aren’t selling all of them.
Here’s why this issue matters. Tax laws allow investors with taxable accounts to use the losses they incur when they sell a stock that’s dropped to offset the taxes on gains from the sales of stocks that have climbed. The losses can also offset up to $3,000 of other income, such as wages, each year. Unused losses carry forward for use against future gains and other income.
“Now that I’ve done research on taxes, I wish I could sell the shares I choose, not a share selected by the ‘Sell’ button,” says Ashton Courson, age 26, a construction worker and manager from Portland, Ore., with about $17,200 in an account at Robinhood he’s not using much, in part for tax reasons.
The option of selling specific lots is readily available at traditional brokerage firms. But Webull, SoFi, Public and Uphold don’t allow it, and Robinhood makes it difficult. This fact shocks professional money managers.
“I think it’s absurd. Taxes are a huge component of investment returns, and it’s an area where investors have some control,” says Bill Mulvahill, a CPA and money manager at Trailhead Planners in Minneapolis.
“It’s crazy—and it’s one reason Robinhood has been a boon to my business this year,” adds Kevin Kleinman, a financial adviser with Blue Haven Capital in Geneva, Ill. Mr. Kleinman said he has more than 10 new clients who were unhappy with Robinhood, and all had tax complaints, among them Mr. Leong.
Smart use of specific-lot identification can minimize current tax bills. Say that a trader holds Tesla shares bought at $400, $650 and $850 apiece since mid-September, 2020. If this person decided to sell some of the winners at a recent price of $675, the taxable gain would be either $275 or $25 per share, depending on which shares were sold. That’s a big difference—and it’s even bigger if some $850 shares were sold, bringing a loss of $175 per share that could offset taxable gains.
Any of these tax results could make sense: An investor with losses elsewhere in a portfolio might want to take gains, and one with gains might want to take losses. But many of the new trading platforms make this hard or impossible to do.
On Robinhood’s webpage about tax lots, the firm doesn’t tell customers they have the option of selling specific lots. Instead, it says sales will be on a first-in-first-out basis, known as FIFO, in which oldest shares are sold first. While FIFO could lower tax rates if the oldest shares have been held longer than a year, it might not. In the Tesla example above, FIFO would give the trader conceivably the worst outcome—a short-term gain of $275 per share, taxed at the rates for ordinary income like wages.
In the fine print of trade confirmations sent to customers after they’ve sold shares, Robinhood does offer the option of specifying lots. But the process is complicated.
Customers at Robinhood can’t specify a lot at the time of sale, as they typically can at traditional brokers. Instead, they search their history and email customer service with six datapoints, including dates and prices, before the trade settles two days after the trade date. Each request is assigned a case number and handled individually.
A Robinhood spokeswoman said it typically tries to tell customers if their request was successful within seven days, but the tax-season rush has temporarily expanded the wait to up to 30 days. Because of a high volume of inquiries, it’s also asking customers to email to find out the request’s status to ensure they’ll receive the information as quickly as possible.
Mr. Leong says he finds the process so daunting he hasn’t used it: “It’s too much work to dig through my order history to find lots and then hope they approve the sale.” In another account at a traditional broker, he says, his specific-lot history pops up as he’s selling shares, and he can easily select which ones he wants to sell.
Mr. Mulvahill, who has experience selling lots online at five different traditional firms, says that at those firms typically lots can be chosen and sold with a few clicks.
A spokeswoman for Robinhood says it’s always looking for ways to improve its customer experience but has nothing to share at this time about changes to the process of specific-lot identification.
Other new platforms don’t allow specific-lot ID at all. Both Webull and Public mandate FIFO for sales, while Uphold sells the most expensive shares available (called highest-in-first-out, or HIFO), and SoFi orders lots so that losers are typically sold before winners.
Anthony Denier, chief executive of Webull, says it’s “looking to add more customization,” and a spokeswoman for Public says the company is “studying tax-minimizing options.” A spokesman for SoFi says tax-lot detail is “on the road map for future releases.” Josh Greenwald, head of trading for Uphold, says the company will consider making changes to tax offerings as it expands.
What difference does tax management make to the bottom line? According to a recent study, systematically taking losses that reduced taxable gains boosted after-tax returns by an average of 0.82% a year from 1926 to 2018 for an investor in a 35% tax bracket. The gains could be larger under some circumstances, says one of the study’s authors, Terence Burnham of Chapman University, such as if an investor traded small or volatile stocks or shorted them.
Dan Herron, a CPA in San Luis Obispo, Calif., who just prepared a return for a client who made more than 10,000 trades on Robinhood last year, says: “I tell clients who trade to specify lots when they sell, or they could get hosed on taxes.”
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