EDUCATION CENTER
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 or exam.)

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 our blog dated Aug. 30, 2013 "The Tax Court Was Right To Deny Endicott Trader Tax Status." See the more current Nelson case, too.

GOLDEN RULES
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 trading days.
Makes close to 500 round-turn trades per year (on an annualized basis).
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 living.
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 tax status:
1. Automated trading without much involvement by the trader.
2. Engaging a money manager.
3. Trading retirement funds.

BOTTOM LINE
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.

Next Steps:

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.

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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