EDUCATION CENTER
Trader Tax Guide Overview

Note that our older Trader Tax Center was packed with tons of excellent trader tax content, which many traders grew accustomed to accessing over the past decade. Click here to enter that older Trader Tax Center and then navigate around the left-side link pages. Please note that we are not updating these older pages, so it's important to use our new Trader Tax Center in this section and the links on the left side of this page.

Overview of Green's 2012 Trader Tax Guide:

Many traders don’t take advantage of all available tax breaks. Unfortunately, far too many accountants still don’t know these breaks or the many nuances and pitfalls that accompany them. You should claim as many tax benefits as possible for the past tax year (i.e., the year for the tax return being filed), file your elections on time, and consider an entity and retirement plan to receive more breaks this current tax year.

Business traders are entitled to several tax breaks, whereas investors are not. By default, the IRS lumps all traders into the category of “investor tax status,” and investors get penalized in the tax code, with restricted investment interest and investment expenses, capital-loss limitations ($3,000 per year), wash-sale loss deferrals, no retirement plans, and more.

To qualify for these tax breaks, business traders must first learn these mostly unpublicized rules, navigate around the vague, yet strict business-qualification requirements, make certain tricky tax elections on time, and execute the strategies properly on their tax return (which also is somewhat difficult). The burden is on you, the taxpayer, to get what you’re entitled to. That may be unfair, but rules are rules — take them or leave them!

Accounting for trading gains and losses is also the responsibility of securities traders. Good software is the only reasonable accounting solution for many securities traders. New tax legislation effective January 2011 requires brokerage firms to report cost basis and holding periods for securities transactions, whereas the prior rules in effect for 2010 and earlier required brokers to report proceeds from the sales of securities on Form 1099-B.

The new IRS cost-basis 1099-B reporting rules usher in a major new tax form for securities traders to deal with on their 2011 tax returns. Form 8949 may be a real challenge for many traders, causing headaches, confusion, additional tax preparation cost and tax notices. It replaces prior-year Schedule D-1 attachments, which used to feed into Schedule D. In 2011, you may not enter disposition directly onto Schedule D, which form must be inputted from another tax form 8949. Form 8949 is constructed to mirror and receive the new 1099-B with cost-basis reporting. Part A is for cost-basis reported, Part B is used when cost-basis is not reported, and Part C is used when there is no 1099-B. You will need good software like TradeLog, otherwise plan to struggle with this form if you are an active securities trader. See Chapter 4 on accounting for more about these changes.

There are also complexities in sorting through different tax-treatment rules and tax rates for securities, stock options, ETFs, commodities, futures, indexes, options on futures, forex, physical foreign currency, foreign futures, precious metals, and other types of instruments. It’s often hard to tell which financial instrument falls into which category. ETFs can be a confusing area for taxpayers, CPAs, and attorneys, so we’ve expanded on the topic in this guide. Forex tax treatment also remains vague. We discussed spot forex with the IRS recently; our findings are included here too.

Some business traders are satisfied to operate as sole proprietors (with a Schedule C) because it appears less complicated, they can claim trader tax status after year-end, and it appears to cost less than other methods. But Schedule Cs draw more IRS attention especially for business traders, because they have trading gains and losses reported on other tax forms. Federal and state tax exams are on the rise, especially for small-business taxpayers (including traders) and upper-income taxpayers.

Last year, we won a favorable decision in an important IRS appeal, defending trader tax status and Section 475 MTM ordinary business loss treatment for a part-time trader and business executive. We established the importance of the “continuous business activity” standard and think it can help traders who fall short on the required frequency of trades standard. New this year: We explain how continuous business activity works and how you may be able to benefit from it.

Retirement plans provide significant tax savings for traders in several different ways. Annual tax-deductible contributions to retirement plans generally save traders more in income taxes than they cost in self-employment (SE) or payroll taxes. A married couple can save up to $17,000 with Individual 401(k) plans established for each of them. SE or payroll tax is charged on the declared earned income component only. (One exception: Members of a futures exchange are subject to SE taxes on their trades made on those exchanges.) New this year: We do the math so you can see exactly how this tax savings strategy works. It’s a very powerful savings tool and a good idea overall.

Traders should avoid the pitfall of taking early withdrawals from regular retirement funds; this is often a mistake made by those looking to fund a trading business. Early withdrawals from retirement plans are subject to regular income taxes (at higher ordinary tax rates) plus a 10-percent excise tax. New this year: We show you how to tap these funds earlier than age 59½. (See Chapter 8 for more on retirement plans.)

PROPRIETY TRADING VS. RETAIL TRADING
The challenge for proprietary traders is deducting their business expenses, including home-office expenses. They are allowed to deduct these expenses even if they trade from the firm’s office as well. Prop traders have difficulty with AGI deductions since its hard to engineer earned income. (See Chapter 12.)

New this year: We analyze the current state of the proprietary trading firm industry and offer our comments and suggestions. It’s important to stay clear of potential trouble. We also address how to handle education/prop trading firm hybrids, and writing off education or deposits.

More traders are rising to the ranks of investment management. Investment managers seek better tax treatment by using “carried-interest” tax breaks passed-through their investment funds. They also reduce SE tax on management fees by using S-Corps. Congress and the administration threaten repeal of these breaks, but they are protected by Republicans. We expand on how carried-interest works and why its a good idea to still use it in your documents. It’s better for investors too. Learn more in Chapter 13.

We added a new chapter this year on foreign matters. Many traders have offshore bank, trading and investment accounts, or they are involved with family assets offshore. The IRS has raised its game big time for foreign compliance and it is busting taxpayers left and right over its onerous reporting rules. Whether its FBAR, new tax form 8938 or the OVDI “come clean” IRS program, all traders need to read our content about these foreign matters and be sure to stay in proper compliance. If you aren’t, work with our tax attorneys to achieve attorney-client privilege. Avoiding this will lead to huge penalties, turning over big monies to the IRS and maybe criminal fines. It’s important!

This is an excerpt from Green’s 2012 Trader Tax Guide • Copyright © 2012