Half to the House?
Tax-drag to the max.
I have covered similar situations in the past. One of the easiest ways to understand tax drag is by comparing a brokerage account to a Roth IRA. But today, let’s exacerbate this. We’ll keep it close to home and use a New York City single filer as our example!
Some engage in short-term trading. I’m sure a lot of you who have been following this newsletter know this, but we’ll review for anyone new!
Short-term capital gains are taxed according to ordinary income brackets. Very similar to how our wages are taxed.
Long-term capital gains are taxed under a more favorable structure: 0%, 15%, and 20%.
State and local taxes can apply to any income and capital gains can be taxed at these levels as well.
One last item: The Net Investment Income Tax. An additional tax of 3.8% that is applicable to single filers who have MAGI (modified adjusted gross incomes) over $200,000 can apply to investment income (interest, capital gains, etc).
Wow! That’s a lot of tax!
For our example, we will be using the 2025 brackets. While outdated, many are still in the process of filing and these brackets will still do the trick in driving home the point.
So, let’s assume our young high earner has taxable income of $300,000 before any capital gains. They did some trading and absolutely crushed it. They realized $100,000 in short-term capital gains. This brings their total taxable income to $400,000.
Here’s how that short-term capital gain would be taxed for our single filer:
Federal: 35%
Income between $256,526 - $626,350 is taxed at 35% at the federal level, meaning all of the capital gain would fall within this bracket.
State: 6.85%
Income between $215,401 - $1,077,550 is taxed at 6.85% in New York state.
Local: 3.876%
Taxable income above $50,001 is taxed at 3.876% in NYC
NIIT: 3.8%
Given MAGI will exceed $200,000 in our scenario, the short-term capital gain will be subject to another 3.8% net investment income tax.
Total: 49.526%
Again, this figure is for illustrative purposes. There are instances in which this figure could be reduced but for simplicity, this figure would be an approximation of the total tax on the short-term capital gain.
A whopping, almost ½, of the gain is forfeited via taxes. This is an astronomical amount of tax to pay for an amazing trade.
If the stock market dropped by 50%, we’d all be feeling it. We have not seen anything of the sort since 2008.
Well, our friend here just realized a 2008 event by way of taxes alone.
Pushing back on all of this, taxes are likely to be the biggest expenses of our entire lives. Purposefully planning and being aware of how these taxes can impact our situation is so incredibly important.
This is for informational purposes only and is not intended as legal or investment advice or a recommendation of any particular security or strategy. The investment strategy and themes discussed herein may be unsuitable for investors depending on their specific investment objectives and financial situation. Opinions expressed in this commentary reflect subjective judgments of the author based on conditions at the time of publication and are subject to change without notice. Past performance is not indicative of future results.