Trader Tax Status
Tutorials: Tax Benefits of Trader Tax Status (mp4s
under 5 minutes each):
GTT Tutorial 1: Business
Expenses For Traders
GTT Tutorial 2: Section
475 MTM Accounting For Traders
GTT Tutorial 3: Employee-Benefit
Plans For Traders
The first step to tax savings is qualifying for “trader tax status,”
which signifies business treatment of trading gains, losses and expenses
as opposed to the default investment treatment.
Business treatment gives full ordinary-loss deductions, including home-office,
education, start-up expenses, margin interest, and much more, whereas
investment expenses are very limited, only allowed in excess of 2% of
adjusted gross income (AGI), and not deductible against the nasty alternative
minimum tax (AMT). Starting in 2013, investment expenses are further
restricted with “Pease” itemized-deduction limitations for
taxpayers with AGI over $300,000 (married) and $250,000 (single). Business
expense treatment is much better.
The average trader saves more than $5,000 per tax year with trader tax
status, and hedge funds also save taxes for their investors. You can
claim trader tax status after year-end; it doesn’t need to be
elected in advance like Section 475 MTM (mark-to-market) and the forex
election to opt out of Section 988. You can claim trader tax status
for the tax year that just ended and even for the prior three tax years
with amended returns by including a Schedule C as a sole proprietor.
(Note: Filing amended tax returns may increase your odds of IRS questions
Full-time active traders generally qualify for trader tax status quite
easily. Part-time traders can also qualify, but it’s more difficult.
The bar is raised in the eyes of the IRS — especially if you have
trading losses with business ordinary-loss treatment (Section 475) rather
than capital-loss limitations.
QUALIFYING FOR TRADER TAX STATUS
Unfortunately, the IRS hasn’t issued specific rules with objective
criteria for how a trader qualifies for trader tax status (business
treatment). This lack of guidance isn’t unusual; the IRS doesn’t
provide objective tests for other types of businesses either. Business
traders face more scrutiny from the IRS, similar to hobby-loss businesses.
But hobby-loss rules can’t be successfully applied against a trading
business (more on this topic later). Arizona tried to apply hobby-loss
rules to a trader and we blocked them from doing so.
Currently, there’s no statutory law with objective tests for how
to qualify for trader tax status. Subjective case law applies. Leading
tax publishers have interpreted case law to show a two-part test to
qualify for trader tax status:
• “Taxpayers’ trading activity must be substantial,
regular, frequent, and continuous.
• The taxpayer must seek to catch the swings in the daily market
movements and profit from these short-term changes rather than profiting
from long-term holding of investments.”
Important new tax court case for options traders: Read
dated Aug. 30, 2013 "The Tax Court Was Right To Deny Endicott Trader
Tax Status." See the more current Nelson
Our golden rules for trader tax status qualification are based on years
of experience. The trader:
• Trades full time or part time, all day, every day.
• Spends more than four hours per day, every market day
working on his trading business.
• Has few to no sporadic lapses in the trading business
during the year.
• Executes trades on more than 75 percent of available
• Makes close to 500 round-turn trades per year (on an
• Has proceeds in the millions of dollars per year on
securities and less is okay on options and futures.
• Makes mostly day trades or swing trades.
• Has the full intention to run a business and make a
• Has significant business tools, education, business
expenses, and a home office.
• Has a material account size.
WHAT DOESN'T QUALIFY?
There are three factors that automatically don’t qualify for trader
1. Automated trading without much involvement by the trader.
2. Engaging a money manager.
3. Trading retirement funds.
Trader tax status drives many key business tax breaks like business
expenses, business ordinary trading losses with the Section 475 election
and AGI deductions for retirement plans and health-insurance premiums.
These items are deducted from gross income without restriction, whereas
investment expenses are subject to itemized deductions and AMT preferences,
and there are capital-loss limitations and wash-sale loss deferrals
to contend with as investors. Unfortunately, only a small fraction of
active traders qualify for trader tax status, and the rules are vague
and difficult to understand. If you’re not sure, consult Robert
A. Green, CPA.
Excerpt from "Entities For Traders."
If you’re thinking about creating an entity for your trading business,
you have options — LLCs, general partnerships or S-Corps. Before
we take a closer look, it’s critical to note that entities don’t
guarantee trader tax status. Your trading must rise to the qualification
level of a business trader before you should consider forming an entity.
If you are
not sure if you qualify for trader tax status, first read Chapter 1
"Trader Tax Status" of 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.
Consider our Trader Tax Status Determination Service
from Green NFH, LLC on your qualification for trader tax status. Click
here to learn more.