EDUCATION CENTER
Section 475 MTM Accounting For Traders

The biggest problem for investors and traders occurs when they are unable to deduct trading losses on tax returns, significantly increasing tax bills or missing opportunities for tax refunds. Investors are stuck with this problem, but business traders can avoid it by filing timely elections for ordinary tax-loss treatment: Section 475 mark-to-market (MTM) for securities and Section 1256 contracts if elected. Section 1256 contracts include futures, broad-based indexes, options on futures, options on broad-based indexes and several other instruments (covered in Chapter 3).

Forex receives ordinary (non-business) loss treatment by default with Section 988; these traders can elect capital-gains treatment for forex on a contemporaneous basis.

By default, securities and Section 1256 investors are stuck with capital-loss treatment, meaning they’re limited to a $3,000 net capital loss against ordinary income. Capital losses first offset capital gains in full without restriction. After the $3,000 loss limitation against other income of any kind is applied, the rest is carried over to the following tax years. Many traders wind up with little money to trade and unused capital losses. It can take a lifetime to use up their capital loss carryovers. What an unfortunate waste! Why not get a tax refund right away?

Business traders have the option to elect Section 475 MTM accounting with ordinary gain or business loss treatment in a timely fashion. When traders have negative taxable income generated from business losses, Section 475 accounting turns the losses into unrestricted and unlimited ordinary business losses and net operating losses (NOLs). Caution: Individual business traders who miss the Section 475 MTM election date (April 15, 2014 for 2014) can’t claim business ordinary-loss treatment for 2014. They will be stuck with capital-loss carryovers and wash sale loss deferral rules will apply at year-end. A new entity set up after April 15, 2014 can deliver Section 475 MTM for the rest of 2014 if the entity files an internal Section 475 MTM election within 75 days of entity inception. That breaks the chain and stops wash sales in the individual trading account. (See our tax planning chapter 9 in Green's 2014 Trader Tax Guide.)

Ordinary trading losses can offset all types of income (wages, portfolio income, capital gains, passive income, etc.) for you and your spouse on a joint filing, whereas capital losses may only offset capital gains. Plus, business expenses and business ordinary trading losses comprise a NOL. Taxpayers can carry back NOLs two tax years and/or forward 20 tax years. It doesn’t matter if you are a trader or not in a carryback or carryforward year. Business ordinary trading loss treatment is the biggest contributor to tax refunds.

You need to qualify for trader tax status in order to use this Section 475 election. There are many nuances and misconceptions about Section 475 MTM, and it’s important to learn the rules. For example, you’re entitled to segregate investment positions that aren’t subject to MTM treatment at year-end, meaning you can defer unrealized gains. You can have the best of both worlds — ordinary tax-losses on business trading and deferral with lower long-term capital gains tax rates on segregated investment positions. The IRS doesn’t permit Section 475 MTM ordinary loss treatment on investment positions, whether they are segregated or not. Far too many accountants and traders confuse trader tax status and Section 475; they are two different things, yet very connected. Confusion leads to missed elections, overpayment of taxes and missed opportunities for significant refunds.

If you are not sure if you should elect Section 475 MTM, first read Chapter 2 on Section 475 MTM in Green’s 2014 Trader Tax Guide.

Next, consider a 30-minute consultation with Robert A. Green, CPA or Darren Neuschwander, CPA, co-managing members of Green NFH, LLC.

This is an excerpt from Green’s 2014 Trader Tax Guide

Copyright © 2014

 

     

Highlighted Recent Recordings:

*Entities & Employee-Benefit Plans
*Current Developments in Tax Law that Affect Traders
*Accounting for Traders
*The Section 1256 club is hard to get into: Futures on foreign exchanges often donít qualify
*Puerto Ricoís tax haven status
*Entities: A key update on trading entities and management companies
* 2013 Tax Filings For Traders & 2014 Tax Planning
*Forex Tax Treatment & Planning
*Trader Tax Law Update: Current Developments
*2014 Tax Planning & Will an Entity Help Lower Your Tax Bill?
*Audits of Performance Records

Trader Tax Center

Tax Newsletter & Calculators

Highlights (see the full archive):

Aug 19: Foreign partners in a U.S. trading partnership can be tax free Read More

Aug 13: IRS warns Section 475 traders Read More

June 20: Tax treatment for Nadex binary options Read More

June 19: IRS softens its stance for some taxpayers with undeclared offshore accounts Read More

June 12: IRA rollover rule changes Read More

June 6: Bitcoin is not reported on 2013 FBARs Read More

June 5: Tax deadlines in June: U.S. residents abroad and FBAR Read More

June 2: Tax treatment for foreign futures Read More

May 21: Bitcoin tax update: Can business traders apply Section 475 elections to bitcoin trades? Read More

May 13: Puerto Ricoís tax haven status is tailor made for investors, traders and investment managers Read More

May 6: Entities: A key update on trading entities and management companies Read More

Mar 25: IRS guidance on bitcoin transactions will chill its use Read More

Feb 27: Another trader tax court loss (Assaderaghi) Read More

Feb 1: Net investment tax details Read More

Dec 4: IRS final regulations for Net Investment Tax help traders. Read More

Dec 3: Bitcoin is a hot commodity, but is it taxed like commodities, assets, or currencies? Read More

Nov 15: Another non-business trader gets busted in tax court trying to cheat the IRS. Read More

Nov 6: Hedge fund investors depend on ďassuranceĒ from quality independent CPA firms. Read More

Oct 29: ObamaCare taxes are starting to affect traders. Read More

Aug 30: The Tax Court Was Right To Deny Endicott Trader Tax Status Read More

Aug 18: Common trader tax mistakes Read More

July 24: Learn the DOs and DONíTs of using IRAs and other retirement plans in trading activities and alternative investments Read More


GreenTrader blog archive, Forbes blog, Benzinga blog.

 




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