Taxes for the Trader

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Taxes for the Trader

• By Vicki Moore, CPA
• vmoorecpa_at_cox.net

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Disclaimer

• This will be for general education information
  only
• Everyones situation is different so be sure to
  obtain tax advice from your own CPA

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Taxes for the Trader

• The Investor
• Trader Tax Status
• Mark-to-Market Accounting Status
• A Business Entity

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The Investor

• Net Losses are limited to 3000/year
• Expenses are taken on the Sch A, Miscellaneous
  section, subject to 2 limitation rules
• Your expenses may be further limited or
  eliminated if you are subject to AMT (alternative
  minimum tax)

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The Investor

• Investment interest expense is taken on the Sch
  A, Interest section, and is limited to the amount
  of your net investment income (interest,
  dividends, net capital gains (losses) less
  investment expense. Investment interest is not
  subject to the AMT or the reduction of total
  itemized deductions.
• If you make too much money you will have a
  further reduction of your total itemized
  deductions (called the phase out of itemized
  deductions).

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Trader Tax Status

• Report expenses on the Schedule C, Profit or Loss
  from Business
• Exempt from SE tax (passed by Congress in the
  1998 Tax Act)
• You can segregate your Tax Trader gains and
  losses from investment positions to take
  advantage of long-term capital gain treatment on
  investments

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Trader Tax Status

• The IRS two-part test to qualify as a
  Professional Trader
• Trading must be substantial, regular, frequent
  and continuous. Sporadic trading is not allowed
• Taxpayer must seek to catch the swings in the
  daily market movements and profit from the
  short-term changes rather than long term holdings

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Trader Tax Status

• Full Time Trader
• You work full-time on trading and have no other
  major sources of business activity income
• You spend all day every day the markets are open
  trading

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Trader Tax Status

• Part-Time Trader
• IRS may scrutinize your qualification if you have
  another business activity
• The more you work in your trader business, the
  more likely you will be able to prove to the IRS
  you qualify
• If you trade less than once per day, the IRS may
  reject your trader tax status

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Trader Tax Status

• Part-Time Trader (continued)
• Arguments to use for not being available during
  the market hours
• You use stop losses
• You use stop limit orders
• You have access to a computer to trade if
  necessary
• You have monitoring software
• You use alerts from your broker
• You use a phone to place orders (broker is on
  speed dial!)

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Trader Tax Status

• Things to Help You Qualify (full or part-time)
• Trading
• Trade at least 4 hours a day every day
• Make 500 trades per year
• Do mostly day trades if you do swing trades (you
  should have only a few positions held more than a
  few weeks at a time)
• You generate a large amount of sales proceeds
  from churning your account

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Trader Tax Status

• Things to Help You Qualify (full or part-time)
• Accounts and Record Keeping
• Keep a separate checking account and credit card
• You have 1 or more online brokerage accounts
• Keep your investment accounts segregated from
  young accounts
• Keep your records of the activity to justify the
  frequency and total dollar amounts of your
  trades
• Keep a diary recording time spent trading,
  learning, researching, reading searching for
  stocks
• You dont lose money many years in a row

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Trader Tax Status

• Things to Help You Qualify
• Research and Tools
• You buy computers and software just for the
  trading business
• You spend countless hours watching and reading
  business news
• You buy trading books, DVDs and online services
• Attend seminars

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Trader Tax Status

• Reporting income expense with a Tax Trader
  Status
• Expenses on the Sch C, Profit or Loss from
  Business
• Computer hardware, software internet expense
• Home office expense
• Margin interest expense
• Research, books, subscriptions
• Seminars, including travel
• Meals entertainment if there is a business
  purpose (limited to 50)
• Professional tax, accounting and legal expense
• Telephone (business use only)
• Office furniture and fixtures

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Trader Tax Status

• Reporting income expense with a Tax Trader
  Status
• Gains and losses on Sch D Gains and Losses
• Net gains on the Sch D can be transferred to the
  Sch C to the extent of expenses
• Home office deductions will be reported on Form
  8829 Home Office Deductions

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Trader Tax Status

• Reporting income expense with a Tax Trader
  Status
• Depreciation will be reported on Form 4562
  Depreciation and Amortization
• If you are starting in the trading business and
  you are not yet trading regularly and
  substantially, keep track of your expenses and
  make an election to capitalize your start up
  costs according to IRC 195. You will be allowed
  to write off 5,000 in your first year and
  amortize the balance over 15 years, starting with
  the date the business begins.

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Mark-to-Market Accounting (MTM) Internal
Revenue Code (IRC) section 475

• Mark all open trading positions at year end to
  market prices and report gains and losses on your
  open trades as if they were sold at year end
• You will receive ordinary income or loss from the
  trading activity and avoid the capital loss
  limitations and wash sale rules
• If losses are greater than the other income on
  your tax return, you are able to carry back two
  years to obtain a refund from prior years and
  then forward 20 years if not used fully in the
  prior years.
• Must have Tax Trader Status to be eligible for
  MTM

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Mark-to-Market Accounting (MTM) Internal
Revenue Code (IRC) section 475

• Must make an election for MTM
• Make election by April 15 of the same year you
  plan to have it effective (attach to the prior
  year return or the extension)
• For corporations and other entities it is the
  15th day of the 3rd month of the tax year
• Attach election to your prior year tax return or
  extension
• Election is good for all later years unless
  revoked with IRS consent or you simply no longer
  qualify for Tax Trader Status

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Mark-to-Market Accounting (MTM) Internal
Revenue Code (IRC) section 475

• Sample election
• Mark-to-Market Election
• Under Code Sec 475 (f)
• Trading Business Name
• Address
• EIN XX-XXXXXXX (or SS)
• The taxpayer is hereby electing to apply the
  mark-to-market method of
• Accounting under Code Sec 475 (f). The election
  is effective for the tax
• Year beginning 1/1/200X. the election is made
  for the following trade or
• Business
• Trading Business Name
• _______________________________________
• Taxpayer or Entity Name (sign on line)

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Mark-to-Market Accounting (MTM) Internal
Revenue Code (IRC) section 475

• File Form 3115, Change of Accounting Method
• File Form 3115 with the tax return for the first
  year of change (i.e. you attach the election
  effective 1/1/2008 to your 2007 income tax return
  and file the Form 3115 along with the 2008 tax
  return)
• Label form 3115 as filed under Section 10A of
  the Appendix of Rev Proc 2009-9
• Calculate the tax effect on the change for the
  beginning of the year as an IRC section 481 (a)
  adjustment. Spread the adjustment over the year
  of change and the next 3 years. A negative
  adjustment is taken in the current year.

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Mark-to-Market Accounting (MTM) Internal
Revenue Code (IRC) section 475

• Reporting income and expense with MTM method
• Expenses are included on the Sch C Profit or
  Loss from Business
• Gains and losses are included on Form 4797 Sales
  of Business Property
• Net gains on Form 4797 can be transferred to the
  Sch C to the extent of losses
• Home office deductions will be reported on Form
  8829 Home Office Deductions
• Depreciation will be reported on Form 4562
  Depreciation and Amortization

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Mark-to-Market Accounting (MTM) Internal
Revenue Code (IRC) section 475

• When not to make the MTM election
• If your trades are longer than 1 year it is
  better to be an investor obtaining the favorable
  long-term capital gains treatment at reduced tax
  rates.
• If you trade commodities or futures and are
  profitable you qualify for long term capital gain
  tax rates on 60 of the income under IRC Section
  1256
• If you are making a lot of money on strategies
  that will not allow you to have tax trader
  status, dont try to get MTM. Keep doing what
  youre doing!

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A Business Entity

• Reasons to set up a separate entity
• You can obtain earned income with guaranteed
  payments from a partnership or salary from
  corporations. Reasons you want earned income
• For retirement plan (Mini 401k, Simplified
  Employee Pension Plan, Simple Plan, Defined
  Benefit Plan, Roth IRAs)
• For health benefit plan
• To be able to receive social security benefits
  and medicare when you retire
• Want to put as much into the IRA to take
  advantage of the Roth Conversion in 2010
• Protection from liability

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A Business Entity

• Some Things to Consider in Setting up an Entity
• You can obtain earned income from an entity which
  makes it possible to have a retirement plan
  and/or health benefits and to build up the amount
  of social security benefits at retirement
• Do the benefits outweigh the costs to have a
  separate entity?
• Dont believe those that say you will not be
  looked at by the IRS as easily if you have a
  business entity vs. a Schedule C there are more
  and more audits on business entities now

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A Business Entity

• More Things to Consider in Setting Up an Entity
• A trader in an entity may be liable for the debts
  of the entity due to personal wrongdoing or
  piercing the corporate veil
• You will not be completely protected from
  liability, although it makes it more difficult
  for a creditor to get your assets in a legal
  entity
• An LLC is subject to the minimum 800 tax plus
  California Gross Receipts fee for gross receipts
  in excess of 250,000 (most traders have way more
  than this!). Fee ranges from 900 up to 11,790

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Sources

• Internal Revenue Code, Regulations, Revenue
  Rulings
• CCH Master Tax Guide
• RIA Checkpoint Tax Research Program
• The Tax Guide for Traders by Robert Green
• CA CPA Education Foundation
• IRS Publication 550