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CENTER
Entities for Traders
(Click
here for a list of our entity services.)
WHY ENTITY?
Although entities aren’t absolutely necessary for business traders,
they’re very helpful in reducing IRS scrutiny. This is because the
entity tax return is filed separately, so the IRS won’t see W-2
(wages) from another full-time job, or retirement income.
Additionally, entities help traders elect Section 475 MTM (ordinary-loss
treatment) later in the tax year if they missed the individual MTM election
deadline on April 15. “New taxpayers,” such as a new separate
legal entity or a new individual taxpayer who never filed before may elect
Section 475 within the first 75 days of inception. (Only new trades within
the entity qualify for MTM treatment; current-year individual capital
losses and capital-loss carryovers aren’t included in Section 475
MTM ordinary-loss treatment elected in the entity.) Traders must qualify
for trader tax status in order to elect and use Section 475 MTM.
Entities unlock adjusted gross income (AGI) tax deductions, including
retirement plans and health-insurance premiums (at 100 percent). Business
traders often use entities to contribute to a retirement plan, which otherwise
isn’t possible unless a trader has other sources of earned income
or is a dealer member of a futures or options exchange.
WHERE SHOULD I FORM MY ENTITY?
Form your trading entity in your home state, unless you plan to move to
a new state soon. General partnerships are portable from state to state
because they aren’t incorporated or organized in any given state.
Pass-through entities pass income to your home state, so setting up out
of state doesn’t save on taxes and can cause extra expenses and
trouble with your home state.
GENERAL PARTNERSHIPS
General partnerships between spouses are a good choice in many states
because they’re the most inexpensive to form and maintain. Partnership
tax returns should use administration fees (not guaranteed payments) to
financially engineer earned income.
LIMITED LIABILITY COMPANIES (LLCs)
Limited liability companies commence operations on the date they’re
filed with the state or even later. Multi-member LLCs usually file partnership
tax returns in the same manner as general partnerships, so tax matters
are basically the same. LLCs can also elect to be taxed as S-Corps or
C-Corps.
SINGLE-MEMBER LLCS (SMLLCs)
SMLLCs are “disregarded entities,” a “tax nothing”
in the eyes of the IRS. An individual owner reports SMLLC business activity
just like a sole proprietorship on a Schedule C. Consider electing S-corp
status on your SMLLC.
Excerpt from the Executive Summary in Green's 2013 Trader
Tax Guide:
BUSINESS TRADERS SHOULD USE A PASS-THROUGH ENTITY
We strongly recommend a trading entity to claim and use trader tax status
related tax breaks. Business deductions save traders around $8,000 or
more per year. A trading entity unlocks AGI deductions for retirement
plans and health insurance premiums, saving traders $2,000 to $17,000
more. A trading entity disconnects wash sale loss treatment with your
individual return and in your IRA.
A new entity provides more flexibility for electing, using and exiting
from Section 475 MTM. If you have a big capital loss carryover to work
your way out of, the entity gives you the flexibility to use up those
capital losses with capital gains passed through from the entity. If you
have a big new loss in the entity, you can elect Section 475 MTM ordinary
loss treatment instead. Next, simply form a “do-over” entity
with the capital gains treatment until you use up your carryover capital
losses.
If you’ve been on the fence about forming a new trading entity,
consult with us about it this year. Our entity formation service is low
cost, fast and just what you need. We continue to recommend simple pass-through
tax entities like LLCs, S-corporations and general partnerships for a
husband and wife. The trading entity files a separate tax return and the
summary of income, gain, loss and expense is passed on to the owner’s
individual tax return, where taxes are due or refunded.
Our tax attorney prefers an LLC over a general partnership (GP) for a
husband and wife, as the IRS may respect that structure more for business
treatment. Our many existing husband-wife GPs are fine, but we may want
to consider an LLC for new clients if it’s not costly in your home
state.
Our tax attorney continues to stress that a single-member LLC should elect
S-corporation status to file a separate tax return or admit a spouse for
a partnership return, as the IRS may reject an internal Section 475 MTM
election from a disregarded entity. If you remain a SMLLC, you need to
file an external Section 475 MTM election, just like an individual.
Our administration fee strategy works well and we haven’t heard
about any issues with it.
Notes about C-Corps (from the guide chapter on entities):
Unlike S-corporations, C-corporations don’t pass through trading
losses and expenses to the owner’s individual tax return, where
they could otherwise generate immediate tax refunds. C-Corps aren’t
preferred to operate a trading business, for several reasons (no loss
passthrough, no 60/40, double taxation and more listed in the guide).
We suggest using a C-Corp — not as a trading entity but to hold
intellectual property — to avoid Obama-era income tax hikes on upper-income
taxpayers starting in 2013. For a specific scenario of how this works,
see “Example: 2013 tax savings using entities” in the guide.
These are excerpts from Green’s
2013 Trader Tax Guide • Copyright © 2013
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