GameStop Stock Sales are a Big Payday for Tax Collectors
In December 2020, GameStop was a struggling retailer with a foregone conclusion. Selling hardcopies of videogames when over 80% of videogames are downloaded from digital copies, compared to 20% a decade ago, is not generally a long term business model. Initially, GameStop’s stock value reflected this. Its lowest share price for 2020 was $2.57. But on January 29th, GameStop’s stock price skyrocketed to $483.00, an increase of 18,693%.
No massive shift in the videogame or retail market is responsible for GameStop’s astronomical increase in stock value. In fact, its dire position as a company made such an event possible. Hedge funds and other large capital investors began short selling GameStop stock.
Traders on the now-famous Reddit page r/wallstreetbets believed they could drive GameStop’s stock price upwards by purchasing stocks themselves and causing a “short squeeze.” Purchasing and holding GameStop stock pushed stock prices upward due to decreased stock volume, and GameStop short sellers would be forced to repurchase stocks at unprofitable prices. As short sellers scrambled to purchase GameStop stocks, even at massive losses, the stock price continued to soar upwards.
GameStop investors who purchased the stock at much lower prices than $483.00 per share hit pay dirt. A line cook who’s restaurant had closed due to the COVID-19 pandemic made $11,400 in one day from trading GameStop stock. The popular YouTube stock channel streamer “Roaring Kitty” claimed his GameStop position increased by $33 million. Ryan Cohen, founder of the pet supply company Chewy.com, purchased a 12.9% ownership of GameStop in 2020 for $76 million. At the stock price high of $483.00, Cohen’s portion of GameStop grew to over $4.2 billion in value.
Since that high mark, GameStop’s share price has been a rollercoaster – falling below $40 and back above $350. But for those GameStop investors who bought their shares less than a year ago and sold for a sizeable profit, short term capital gains taxes are owed to the federal government and some states.
Capital gains are a unique form of taxable income earned from selling profitable assets as opposed to wage income, but short term capital gains are taxed at the same rates as wages. While Roaring Kitty has not yet announced a profit from selling his GameStop stocks, traders like him that have realized well over $500,000 in profit from GameStop fall into the top federal income tax bracket and face a tax rate of 37%. Other traders with smaller profits will still owe the IRS at least 10% on their capital gains.
The capital gains tax liabilities do not stop here. Many states levy a capital gains tax through their personal income tax in addition to the rates levied by the federal government. In high income tax states like California, New York and New Jersey, state capital gains tax rates can exceed 10%. In fact, if a hypothetical GameStop trader in San Francisco sold their stock for $600,000 in profit, their federal, state and local top tax rate would be over 50% before deductions.
But there’s good news for Texas investors. Just like eight other states, Texas does not collect capital gains taxes. Because taxes represent a cost of doing business in one state versus another, potential profits also differ depending on which state an investor realizes their profits in. For example, a hypothetical $50,000 investment gain in California becomes $35,351 after taxes. If that same investor realized their capital gains in no-income-tax Texas instead, their profits would be $40,600 after taxes – a $5,639 difference.
Investors should begin paying closer attention to state capital gains tax policy. While state revenue losses during the COVID-19 pandemic were not as bad as initially thought, many states are still using the pandemic as an excuse to raise taxes. Washington state lawmakers are considering a 9% income tax on capital gains, a proposal that has the backing of Governor Jay Inslee. The Maryland General Assembly is also considering a 1% surcharge on any capital gains income in addition to the normal state personal income tax rates.
Of course, if other states succeed in increasing capital gains taxes, Texas stands to benefit. As capital gains taxes increase in other states, Texas’ no-income-tax policy becomes more competitive for economic growth as investors realize they can maximize their profits by moving to Texas and realizing capital gains here instead.
The saga of the GameStop short squeezers is one of the most astounding Wall Street stories since the 2008 recession. Overnight, investors become millionaires because of information learned from a Reddit thread. But before they celebrate, these traders must pay the tax man what they owe. They’ll soon realize why low-tax states like Texas are in a much better position to attract investors and capital than states with more extractive tax rates.