Coronavirus and Stock Market Drops: What They Could Mean for Next Year’s Taxes

The onset of Coronavirus, or COVID-19, resulted in many changes to our daily lives. School closures have led to forced home schooling and many areas have experienced a rise in cases of late.

Many businesses are facing temporary closures, and small businesses are facing the possibility that their doors may not open again. Business closings mean many employees are no longer being paid, and that has a lasting effect on families, businesses, and the overall economy.

Times are grim, and the stock market is seeing continued fluctuation — including all-time lows — but there are still a few options left to help minimize the impact on your finances for next year’s taxes.

Capital Gains

Put simply, if you sell an investment (like stocks) for more than you paid for it, you have capital gains. Or, as most people think of it, you’ve made a profit.

Those capital gains are usually taxed, and depending on your income, they could be taxed as much as 20 percent if they are a long-term capital gain (held more than one year). That can add up to a pretty hefty sum, so having an investment loss can actually reduce your capital gains tax bill — helping you keep more money in your pocket when the market is down.

To reduce your capital gains, the loss must be realized in 2020.

Investment owners world-wide are watching the majority of their investments go up and down right now. Fluctuations on the stock board are considered paper gains or paper losses. Meaning, you haven’t taken action to sell, you’re just observing the market.

Market fluctuations alone will not reduce your capital gains or offset your taxable income. To claim your investment losses, you need to realize the losses.

While we’re sure you absolutely realize the losses you’re taking, we’re referring to the act of selling your investments.

To see a reduction on your 2020 taxable income (the taxes you’ll file in 2021), you’ll need to sell the investments you have paper losses on in 2020. So, investments that sell for less than you bought them for.

Your retirement account could be affected

In most cases, the value of your IRA or your 401(k) won’t affect your taxes. Traditional IRAs and 401(k)s are funded with pre-tax income, so as far as the government is concerned that’s ‘paper’ income.

A Roth IRA, however, could affect your taxes. If your Roth IRA loses value, you could claim that loss on your taxes, but you’ll likely need to close any similar IRAs you have.

Market Recovery

Market losses are felt worldwide. A drop trickles down and causes a ripple effect. The good news is that the stock market has already started to bounce back compared to where it was in March and April of 2020. Those who are able to push through paper losses generally see higher capital gains when the market recovers.