GTT Guide: Trader Tax Law & Benefits ($39.95)
TAX LAW & BENEFITS
(includes Trader Tax Status, Mark-to-Market Accounting, Net Operating Losses,
Case Law & IRS Exams, Securities vs. Commodities, Entities, Retirement
& Fringe Benefit Plans, Proprietary Trading, Self Employment Taxes,
Tax Planning and more)
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The above "GTT Guide: Trader Tax Law & Benefits ($39.95)
comes free with Robert Green's new hardcover book "The Tax Guide for
Traders" ($55), published by McGraw-Hill in October 2004.
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(12/04), and Amazon (12/04).
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Are you a “business trader”?
If you actively trade financial products (securities, commodities, futures
and/or currencies) with the intention of making a living (as an individual
or an entity), you can qualify for business treatment with “trader
It is well worth your time and effort to learn about trader tax laws
and benefits. Learn how to deduct every business-related expense possible
including home-office, education and much more, generating average savings
much greater than $10,000 per year. Elect mark-to-market (MTM) accounting
on time so you can get immediate tax refunds on all your trading losses,
without limitation (in other words, MTM acts as “tax loss insurance”).
Without MTM, you are stuck with capital loss limitations and wash-sale
rule deferrals. Learn how to use entities for added tax savings on retirement
and fringe benefit plans. Investors get the shank in the tax laws, but
traders get the golden goose – the only problem is that you must
learn about these laws and make key elections and filings on time. Most
traders miss the boat, but you just caught it by finding this guide. Now
read it and prosper.
Business tax returns
Individuals who qualify as being in the business of trading rise to the
level of “trader tax status” from the default level of “investor
tax status.” With business rather than investor tax treatment, these
individuals file business tax returns as part of their individual tax
returns on a Schedule C (Business Profit or Loss).
Individuals may also operate their trading businesses in an entity and,
providing they reach trader tax status on the entity level, they are allowed
to use business treatment for all their expenses on the entity tax returns.
Both individual and entity tax returns for trading businesses report business
expenses rather than investment expenses, leading to significant tax savings.
Trading business expenses are treated as “ordinary” expenses
and they can be offset against any type of taxable income (ordinary, portfolio,
capital or passive). Negative income (excess expenses) contribute to Net
Operating Losses (NOL), which may be carried back two tax years, also
against any type of income, for immediate tax refunds.
You may use business expenses on your current year and prior three-year
tax returns (if amended). No election is required and you and/or your
accountant make this determination on your own. Trader tax status is the
most important determination, so carefully read the laws and cases and
be certain you qualify; otherwise you may have trouble with the IRS –
and if you do, learn how to win your case.
Qualifying traders may elect to use mark-to-market (MTM) accounting (IRC
§ 475) by the election deadline of April 15 of the current tax year.
As an example, if you wanted to use MTM for tax year 2004, you needed
to elect MTM by April 15, 2004. If you did not elect MTM, then you may
not use MTM and you must use the default "cash method." The
cash method is the same as what investors use, meaning that all trading
gains and losses are treated as capital gains and losses and are subject
to the wash-sale rules (a real headache). MTM converts capital gains and
losses to ordinary gains and losses, so there is no limit on the amount
of losses that can be deducted (there is a $3,000 limit on capital losses).
MTM traders are also exempt from wash-sale rules. If you tried to elect
MTM on time but did not do so because you got bad advice from your accountant,
or you have some other reasonable excuse, there are limited opportunities
to file extensions.
MTM is good for securities business traders and losing commodities traders,
but it is not recommended for profitable commodities traders who want
to retain the 60/40 benefits of IRC § 1256. If you have capital loss
carryovers (i.e., tax baggage), there are many nuances and some gambles
in electing MTM. Learn all the nuances and complexities, so you make the
right decision about MTM and you save more tax money.
The capital loss limitation rules are a joke for active business traders
who can make or lose much more than the miniscule allowed annual deduction
of $3,000 per year. Every trader that misses making the right decisions
on MTM is putting themselves at great disadvantage. The biggest cause
of failed trading businesses is large capital losses that can’t
generate immediate tax refunds to help keep traders in the game with capital
Net Operating Losses (NOLs)
In addition to MTM, business taxpayers are allowed another huge tax benefit
– Net Operating Losses (NOL) – that non-business taxpayers
entirely miss out on. NOL tax laws provide the opportunity to carry back
or forward business losses, business expenses and MTM trading losses in
excess of your other income. In effect, you can average your income and
losses out over three tax years, which is perfectly suited to the special
needs of business traders. Make a fortune in one year, pay your taxes,
then lose a fortune in the following years and carry back your NOLs for
immediate tax refunds to replenish your trading accounts and stay in the
NOL carryback tax returns are complex for traders and the IRS is watching
closely, obstinate about not paying huge refunds – although traders
are clearly entitled to them. Learn how to properly file an NOL return
– one that creates the fewest red flags – and how to deal
with the IRS if they raise any questions. Do one little thing wrong and
you may cause an exam and jeopardize your tax refunds. When it comes to
NOLs, it’s wise to consult with a CPA or tax attorney who is an
expert in trader tax and NOL returns. Be on the lookout for states suspending
NOL carrybacks or carryforwards.
Qualification can be difficult
OK, I’m convinced. Trader tax status and MTM are the only way to
go, and I can protect myself on the downside with “tax loss insurance”
and get big refunds. It can’t be this easy.
It’s not. Many traders face a difficult task in determining if
they qualify for trader tax status. Unless you trade every day all day
as your primary means of making a living (and are successful at it), the
IRS may attack your status (and IRS audits for traders are on the rise).
The IRS is particularly wary and in fact prejudiced against part-time
traders, part-year traders and money-losing traders. A large percentage
of business traders may fall into one of these special statuses, but don’t
be scared off from using and benefiting from trader tax status. Learn
about the special circumstances that apply to these statuses, how to reduce
the red flags on your tax return and how to deal with the IRS if they
attack your status and win.
Watch out for some snake oil salesmen, including other trader tax firms,
that promise guaranteed trader tax status using multiple entities schemes.
It will cost you thousands extra and it won’t deliver trader tax
status – only your actual trading activity will help you qualify.
Look before you leap when it comes to entities schemes. The best entities
for traders are included in this guide (see below).
Money-losing Traders – be aware of an IRS attack.
Traders who lose money every year may be challenged by the IRS
under the "not-for-profit activity loss rules" (otherwise known
as the "hobby loss" rules). We explain the rules and show you
how to win on this type of IRS attack. We show you also how to build a
better case from the start with business plans, accounting systems and
diaries to document your “intent” to operate a business.
Part-time Traders – you can qualify, but the bar is raised
Part-time traders may qualify for trader tax status. However, be ready
for a fight from the IRS, if you don't trade every day, all day. If you
have another job or business activity besides your trading business, you
should be aware that the IRS may challenge your trader tax status in a
future tax exam. We explain the rules and show you how to win on this
type of IRS attack.
The IRS is examining more traders and attacking their “trader tax
status” which, if successful, causes the disallowance of tax deductions
for trading business expenses and MTM trading losses. The ugly consequence
is no refunds; instead, a tax bill – plus interest and penalties
– is possible.
Learn how the IRS works in their audits – what they focus on and
how you can expect to be treated. Learn how to beat them at their own
game, how to cite trader tax court cases in your favor and how to win
an exam even before it’s fully underway. Our firm has had great
success with traders all around the country when hired to represent them
before the IRS – whether we prepared their returns or others did.
We share all our winning experience with you, and you just can’t
get this really important stuff anywhere else.
Better yet, after you understand how the IRS may react to your return,
you can prepare your tax return with fewer red flags, better footnotes
and strategies. This may prevent an exam in the first place. For example,
if you are a very close call, don’t file a NOL carryback return
and instead carry it forward.
Trader tax laws are complex but also very vague, which forces you and
the IRS into relying on “case law” – a collection of
tax court cases applying to investors and traders. Not only do you need
to learn and apply trader tax laws, but you also need to master a huge
body of case law, which is not readily available, analyzed or organized
– until now, since we have done just that and you can’t find
this anywhere else.
We mention the favorite cases the IRS likes to cite in attacking traders
and we show you how to use these same cases to support your position rather
than the IRS’. We also cite cases that help you and the IRS chooses
not to mention. Case law for traders is very new and the IRS seeks to
apply cases that are more appropriate for investors and not Internet-era
business traders. Our observations, analysis and recommendations bridge
the gap and provide the winning argument. Learn all the ropes in this
exclusive in-depth “case law” section.
We also include all the trader tax laws as written, point out the vague
areas and then add our observations, recommendations and strategies. Our
final strategies and recommendations are based on a combination of trader
tax law and case law, so we make it simple for you to act with confidence.
For the many accountants and lawyers who buy our guides every year, we
pack them with all the citations, actual law and details – they
like reading this stuff – but you traders can skip those parts if
Mark-to-market (MTM) accounting (IRC § 475) is the preferred method
for securities business traders for four reasons: You don’t give
up anything if you have trading business gains (same tax rates for cash
and MTM methods on short-term capital gains), you benefit greatly if you
have losses (ordinary loss treatment rather than capital loss limitations),
you are exempt from the wash-sale (straddle and constructive receipt)
rules and you still benefit from lower long- term capital gains rates
on your “segregated investment positions.”
Commodities & Futures Trading
Commodities and futures are taxed differently from securities. You need
to learn about IRC § 1256 contracts, Form 6781 and special carry
backs, and how they relate to IRC § 475, the new mark-to-market rules.
MTM (IRC 475) is not a preferred method for profitable commodities and
futures business traders for one reason: With the default method, commodities
and futures trading gains are 60 percent long-term and 40 percent short-term
(and long-term rates are significantly lower); MTM (IRC 475) commodities
and futures trading gains are all short-term. IRC § 1256 also has
a loss carry back feature; you can carry back commodities and futures
trading losses three tax years, but only against commodities and futures
trading gains in those years (so you may be able to forgo the IRC §
475 ordinary loss carry back benefits).
Not confused enough yet - between the two types of MTM and tax differences
between IRC § 475 and IRC § 1256 – you will be confused
further between what is a security versus a commodity or future to begin
What’s the (Tax) Difference?
There has been a bevy of new financial products launched by securities
and commodities exchanges the past few years, including but not limited
to ETFs (Exchange Traded Funds), E-minis (an index), single-stock futures,
plenty of other new stock indexes, and options and futures on almost everything.
Before you start trading an instrument, find out how it’s taxed.
Generally all new instruments are either taxed like securities or IRC
§ 1256 contracts (commodities and futures) and the later currently
enjoy a significant lower tax rate savings.
Single-stock futures are taxed like their underlying securities (stock,
options and narrow based indices) and not like commodities (commodities,
futures, and wide based indices).
Stock indexes that are “narrow-based” are taxed like securities.
Conversely, if the index is comprised of ten or more securities, it is
considered a “broad-based” index taxed like commodities.
Interbank (Forex) currency traders are entitled to "elect out"
of IRC § 988 (the ordinary gain or loss rules for special currency
transactions) to achieve IRC §section 1256 treatment; providing for
the lower "60/40" capital gains tax rates.
Find your way through the myriad of new financial products and how they
are taxed in this guide. Learn strategies for electing the best tax treatment
for different types of vehicles and how to combine all these strategies
into one program with trader tax status benefits maintained. There are
many nuances and you won’t find this stuff anywhere else.
Entities for traders
A trader entity allows you to establish a retirement plan and/or other
tax-deductible and tax-deferred fringe benefit plans. These are not available
for sole proprietor traders (who otherwise receive all trader tax status
and MTM accounting benefits). A trader entity can also deliver business
tax breaks to your spouse or investors. If you miss the April 15th MTM
election as an individual, you can form an entity to elect MTM for the
balance of the tax year – since you make an internal election as
a “new taxpayer.”
An excellent solution for many traders, with some hidden gems for late
MTM elections, is husband/wife general partnerships. They are free to
form, the paperwork is easy to assemble and there are rarely any state
taxes to pay. Plus you can achieve all the best strategies, whether your
spouse is active in the business or not.
If you are not married, a single-member LLC is a great entity for many
traders. A separate tax return is not required for this entity and you
save accounting fees every year by reporting this activity on your individual
Part-time traders who are not married may benefit from an S-Corp, as
a separate tax return may deflect some IRS questions about part-time trader
Whatever you do, stay clear of C-Corps to avoid double taxation and trapped
losses that don’t provide any tax benefits. C-Corp/LLC schemes sound
good on the drawing board, but they are highly expensive and don’t
provide most of the benefits promised.
Every state has different tax rules and rates for various types of entities,
so make sure to customize your entity for your home state. Traders face
trouble when they use entities in tax-free states, outside their home
state, because they live and work in their home state. When it comes to
entities, watch out for snake oil salesmen and consult with a CPA or attorney
you can trust and who are experts in trader taxation.
Retirement plans for traders – which ones are best for
Profitable traders should save for their retirement, just like all other
businesses and individuals. Uncle Sam makes it worth you while with tremendous
tax incentives, including generous deductions and tax credits. Consider
these excellent initial returns on your money. Plus consider the power
of compounded tax-free annual returns – wow can your money grow
A Mini 401(k) plan is the plan of choice for traders. You get both an
elective deferral from a traditional 401k plan plus a maximum defined
contribution plan, all in one. Big earners can sock away even more with
defined benefit plans including 412(i) plans. Roth IRAs are also very
attractive for traders.
If you want to use your retirement plan accounts as part of your trading
business, watch out, you could be in for some nasty surprises from the
IRS and ERISA! Learn the rules and some limited ways to navigate around
Retirement plan assets can grow to become your most important and biggest
nest egg, so use this guide to customize the best type of retirement plan
for traders and learn how to stay out of trouble when trading those assets.
It’s just too great an asset to risk losing.
Fringe Benefit Plans
By employing your spouse and classifying yourself as a “spouse of
a non-owner/employee,” you can unlock valuable fringe benefit plan
tax savings in a pass-through entity; the preferred choice for traders.
Fringe benefit plan amounts are the same for C-Corps and pass through
entities, when utilizing this strategy.
C-Corps are a poor choice of entity for business traders. Double taxation
is costly, especially if you are highly successful. If you have trading
losses, you can not pass-through those losses to your individual tax return
for immediate tax relief. With a “pass-through” entity, a
business trader avoids double taxation and gets immediate tax refunds
on trading losses. All items of income or loss are passing through to
the individual tax level and taxes are not paid on the entity level. There
are no remaining advantages to a C-Corp. Business traders can use a pass-through
entity coupled with the “spouse of a non-owner employee” strategy
to unlock every conceivable tax benefit.
Fringe benefits are known as “perks,” including health, life
and disability insurance; education, dependent care and adoption assistance;
meals, lodging and parking; and many other types of plans.
Learn how to convert your fixed family expenses into tax deductions which
can put another $10,000 of so per year in your pocket. If you have some
time and inclination, you can enjoy the same types of perks that corporate
When you take a "job" or "position" with a proprietary
trading firm and trade the firm's capital (instead of trading with your
own money), you are considered to be "proprietary trading."
Proprietary firms handle tax matters in a variety of ways: "employees"
get a W-2; a Form 1099-Misc. is used for "independent contractors";
and Form K-1s for LLC members.
In many cases, the firm handles taxes for its traders in a way contrary
to the best tax-interests of the trader. In those cases, proprietary traders
can benefit from overriding the firm's tax handling, gain trader tax status
and report their true economic gains and losses as a "trader in securities
Proprietary traders receiving Form 1099-Misc for “compensation”
generally owe self-employment (SE) taxes on this earned income. However,
they can argue they are truly traders in securities responsible for their
own trading gains and losses - and the payments are disguised trading
gains. With this override, they can avoid owing SE taxes – a significant
Proprietary traders receiving Form K-1s for their share of trading gains,
losses (and other income and expense if any) are exempt from SE tax plus
they have opportunities to deduct non-reimbursed business expenses, including
but not limited to home-office expenses. Caution, if your proprietary
trading firm has an expense reimbursement plan make sure to use or lose
it before year-end.
Non-U.S. Resident Traders – some may owe U.S. taxes
Many "international taxpayers", who otherwise do not pay US
taxes, have opened US based brokerage accounts and they have questions
about what US taxes they owe in the US. We provide below, a full set of
resources for international investors, traders and proprietary traders.
If the non-resident is a member of a U.S.-based "pass through"
taxable entity, in the business of trading securities or commodities,
then that person has "effectively connected income" (ECI). That
person must file a non-resident tax return, Form 1040NR, to report their
ECI income and pay U.S. taxes on that income.
Wise taxpayers should do special tax planning through-out the year; before
April 15 (MTM elections and trader tax status), during the year (to monitor
trader tax status) and at year-end (to save taxes in the current and future
year). Traders have more to think about then other types of taxpayers.
Don’t wake up to bad news just before April 15th, when it’s
usually too late to accomplish much in terms of saving more in taxes.
If you are tardy at least make sure to focus on April 15th planning for
the current rather then prior year and get your hands around your entire
tax affairs in December.
Tax Law Changes for Traders
Congress and the White House is always tinkering or suggesting drastic
change to the income tax code. Business traders benefit from having most
of their benefits occur “above-the-line” as part of gross
income. We address new tax legislation passed and on the agenda and show
traders how to benefit and set up tax plans that can stand the test of
time and change.
Traders are exempt from self-employment taxation, except if they are commodities
dealers or traders registered on an exchange, proprietary traders compensated
with a Form 1099, or entity traders paying themselves a fee.
Short sales, payments in lieu of dividends and other special types of
transactions cause further complications for traders.
Everything you need to know as a trader for tax purposes are included
in our line of trader tax guides (see our companion securities
tax return examples guides and securities
accounting guide). You won’t need one other resource. And our
entire guides are all new and all researched, written and formulated by
GreenTraderTax.com. We don’t use outside experts or sources because
there are none more qualified then our own. We have self-published our
GTT Guides for Traders for five years and consulted, prepared tax returns
and formed entities and retirement plans for thousands of traders all
around the country. The more we research and service clients and deal
with the IRS, the more nuances and complexities we find. This stuff is
not getting any easier, it’s getting harder, and we continue to
leave our competition in the dust. Get your advice from the most trusted
leading experts in the trader tax business and that’s us.
After you read our guides if you have any questions, use our message
boards, attend our PalTalk
chats and purchase our consultations.
You don’t have to prepare your own tax returns if you find this
too complex, you can hire our firm. Click
here to learn more about our preparation services. Good luck and thanks
for being our customer! We value your business and input.
Robert A. Green, CPA & CEO