TRADERS
SERVICES: ENTITIES

Entities for traders.

Ready to form your entity? Click here to learn more about our entity-formation service and to sign up.

Dangerous entity scams targeting traders. Click here for Feb. 15, 2010 blog article.

Green's 2010 Trader Tax Guide chapter 4 "Entities for Traders." Click here to learn more.

Entities for 2010 (a clean start or a "do over")
Perhaps the situations discussed below (for Q4 2009) don't apply to you, or you don’t qualify for trader tax status. You may decide against forming an entity for the balance of 2009. Instead, you may want start fresh in 2010 with a new entity trading account for the entire year. We can form your new trading entity in late December 2009 and have it set up by Jan. 1, 2010. You have 75 days from inception to file an internal Section 475 MTM election (by March 15, 2010).

Suppose you formed an entity in 2009 and already elected Section 475 MTM to lock in new trading losses as ordinary losses. Furthermore, suppose you have large capital-loss carryovers to use up. You have the option to form a new entity for 2010 — essentially a "do over" on MTM. This strategy puts you back on the cash method starting in 2010. If you generate Q1 2010 losses, you can elect MTM within 75 days of inception; conversely, if you generate Q1 2010 gains, you can skip MTM and use up your capital-loss carryovers.

For these reasons, we prefer the general partnership (husband/wife or parent/child). This strategy allows you to use the same partnership agreement and forms — you simply change the name, obtain a new taxpayer identification number (EIN), and open a new partnership trading account. It's more prudent to use a different type of entity for the replacement entity (e.g., partnership to LLC filing a partnership return) so the IRS doesn't consider the replacement entity a sham.

With this "do over" entity and Section MTM election strategy, you will likely use up capital-loss carryovers and lock in new losses as business ordinary losses for an immediate tax benefit, generally speaking. We rarely need a “do over” with the second entity.

Special note on using a new entity set up in Q4 2009:
Setting up an entity in Q4 2009 is a great way to save tax money this year and next. You can still elect Section 475 MTM in the entity for the rest of 2009, but it's too late to elect MTM individually (the deadline was April 15). You can pay yourself a fee or salary to create earned income, which unlocks a 2009 tax-advantaged retirement-plan contribution (and a deduction for health-insurance premiums). An entity makes trader tax status look better too — something to consider given the IRS’s recent scrutiny toward business traders.

Setting up a new trading entity provides the best of both worlds: It allows capital gains treatment to soak up capital-loss carryovers and year-to-date capital losses, or Section 475 MTM ordinary loss treatment (so you don't waste more unutilized capital losses). As of mid-October 2009, you can make the 75-day from inception internal MTM election after year-end. If you generate trading gains, you can skip the Section 475 MTM election to soak up capital losses. Alternatively, if you generate trading losses, you can make the ordinary tax loss election.

You can offset business ordinary losses against income of any kind; the excess losses are considered a net operating loss (NOL), which can be carried back two tax years. It’s wise to elect Section 475 MTM on futures losses to lock in a large business loss. (Normally, you would not elect Section 475 MTM on futures as you are entitled to lower 60/40 tax rates under Section 1256.)

There are many other nuances and special strategies. A consultation with Robert A. Green CPA is an excellent starting point to see if an entity is right for you. You may later decide to upgrade to our entity-formation service. Click here to learn more about entity tax strategies for traders.

* An entity helps you manage your way out of a capital-loss carryover.
* The entity can also provide an opportunity for a retirement-plan deduction and/or health-insurance premium AGI-100%-deduction.
* Entities are needed now more than before to defend trader tax status because the IRS is turning up the heat on trader tax status (see our blog article on this topic).
* Retirement plans: We recently rolled out our new GreenTrader self-directed retirement planning services. Our plans are customized for GreenTrader tax benefit strategies. They offer special features such as plan loans and the ability to trade forex and futures at many leading brokers and invest in hedge funds. Learn more here. A Mini 401k retirement plan — the preferred plan for business traders — needs to be established (but not funded) before year-end.

Articles on Entities For Traders:

Business traders form entities to achieve maximum tax breaks. Traders who do not conduct their trading through an entity can benefit from business-deduction treatment (and IRC 475 mark-to-market accounting), but they usually need an entity to deduct retirement-plan contributions and health-insurance premiums. Although an entity does not deliver business tax treatment (a trader still must qualify for trader tax status), it does reduce your chances of an IRS inquiry.

Over the past few years, Congress and the Executive branch have both asked the IRS to "Close the Tax Gap" (Google that term), to raise taxes with better compliance (new rules, systems and audits of taxpayers) rather than by raising tax rates alone. This IRS-effort includes more scrutiny and audits of Schedule Cs (profit and loss for sole proprietors and unincorporated businesses) and Schedule Ds (capital gains and losses, primarily focused on securities).

Business traders and active investors unfortunately attract undue attention from the IRS because sole proprietor business traders file a Schedule C reporting either a net loss (from their business expenses) or zero profit (if they use our special strategy to transfer a portion of their trading gains to zero out Schedule C). Sole proprietor business traders report trading gains on other tax forms; Schedule D (securities with cash method), Form 4797 (IRC 475 MTM), Form 6781 (futures), or line 21 of Form 1040 (for forex). The IRS does not like to see a losing Schedule C business, but traders have little choice here. We write about this topic at length in our trader tax guides. Learn more about our IRS exam representation services. A key value of our trader tax guides is to show sole proprietor traders how to file a tax return with few red flags and we include examples of footnotes to include that will nip IRS questions in the bud.

In prior years, we often recommended sole proprietorships for business traders, until they needed an entity for deducting retirement plan contributions and health insurance premiums (AGI deductions). But now that the IRS has ramped up audits again in a way that targets traders too, we recommend a separately filed entity tax return sooner than later. Entities are inexpensive to set-up and maintain for business traders and you only need one entity (not two as a key competitor suggests), so it's a small price to pay for added tax breaks and peace of mind.

Click here to read Robert Green's current article on entities for traders. Edited versions of this article are being published in the CyberTrader Trader Digest (April 2007) and Active Trader (June 2007).

Ready for help? Click here to learn more about our entity formation service and sign up.

Or start first with a consultation first. Click here.

Entities are attractive for traders for a variety or reasons including: help with trader tax status; flexibility on mark-to-market accounting elections; continuity of ownership and protection; retirement plan and health insurance deductions; and incubator hedge fund strategies. Few professionals understand all the nuances for traders and any cookie cutter entity won't due. We customize your entity for your specific needs and you can't beat our price.

A good reason for forming a trader entity is it allows you to establish a retirement plan and/or other tax-deductible and tax-deferred employee benefit plans. These are not available for sole proprietor traders (who otherwise receive all trader tax status and MTM accounting benefits). Another good reason is that a trader entity can deliver business tax breaks to your spouse or investors. If you missed the April 15 MTM election deadline, you can form a ("new taxpayer") entity to elect MTM for the balance of the tax year.

Traders can achieve most income tax benefits using trader tax status and mark-to-market accounting as a sole proprietor trader. In fact, hundreds of thousands of traders file as sole proprietors every year without any problems from the IRS. Sole proprietors can deduct every business expense conceivable without limitation, thereby lowering their taxes as much as possible. Of equal importance is that if the trader loses money, with MTM that trader can get immediate tax relief with net operating loss treatment; their capital loss limitations are converted into full ordinary loss treatment.

We specialize in entity formations for traders in all parts of the country. Start with a consultation to find out if an entity is right for you. Click here to learn more.

Before jumping into an entity, find out all the costs and benefits first. Make sure the benefits far outweigh the costs. Click here to learn more.

Our GTT Entity Consultation and Formation Services are the lowest cost and best services around. It includes everything you need to be up and running within days. Click here to learn more.

Are you in the right situation for an entity?Click here to learn more.

General partnerships owned by family members are the entity of choice providing you don't need entity liability protection. With a GP, the costs are the lowest as there are no state filing fees and in most states no annual minimum taxes. GP's also provide for a "defacto" period giving you more flexibility. Click here to learn more.

Multimember LLCs usually elect to file a partnership tax return like a general partnership except you also have entity-level liability protection. You pay for that by filing with the state and in most states paying a minimum tax and/or annual report fee.

S-Corps are good for single people who can't form GPs or multi-member LLCs. If you are a part-time trader and single, the S-Corp is helpful in attracting less attention from the IRS. S-Corps are also as inexpensive as LLCs in many states, so they are a good alternative for couples that only want one spouse as an owner.

Single member LLCs are "disregarded entities", with income, loss and expenses reported on the owner's tax returns directly. We believe a newly-formed SMLLC can file an external MTM election just like a multi-member LLC, but there is also a chance that an IRS agent could challenge that external election under the disregarded entity rules. We also believe a SMLLC can create earned income to the owner, but again that is more challengeable with a disregarded entity. So it's best to choose a different entity if possible.

Multi-entities schemes will cost you much more in fees, taxes and expenses. You can probably achieve the same desired results with a simpler entity structure. Start with nothing and add what you need. Don't buy-in to the seminar circuit sales pitch of multiple-entity scheme/packages. Often its way more than you need and it doesn't usually work out as planned.

NASDAQ and exchanges charge higher prices for market data to "professionals", who by default include entities; since investors can join an entity. If you can show your brokerage firm that only your close family members are co-owners of the entity, you should be able to keep paying the lower rates for non-professionals. Click here to learn more.

Use "trader tax status" and the "trading rule" (a tax loophole) on the entity level to deliver business tax breaks to yourself and your investors. This is important for family entities and hedge funds. Click here to learn more.

One of the best advantages of an entity for traders is the opportunity to have a retirement plan. General partnerships and LLCs filing partnership returns can simply pay the partners a "guaranteed payment" which is subject to self-employment tax and on which a retirement plan contribution can be made. But if you don't have trader tax status on your partnership tax return, this strategy is not tax efficient. Click here to learn more.

General information on entities for traders. Click here.

Year-end tax planning strategies with entities. Click here.

Ready for help? Click here.

GTT Trader Entity Formation Service – Retainer & Minimum Price For simple LLCs and general partnerships, the fee should not be more than this minimum fee/retainer. If we go beyond basic formation services through extra consultations or making changes to the standard formation documents, the additional time will be charged at our standard hourly rates. S-Corps. can cost a little extra as there is additional paperwork with the S-Corp elections. $625 Retainer Summer Promotion ($125 savings)

GTT Trader Entity Formation Service – Upgrade Retainer & Minimum Price. (If you already purchased a 30 minute consultation). For simple LLCs and general partnerships, the fee should not be more than this minimum fee/retainer. If we go beyond basic formation services through extra consultations or making changes to the standard formation documents, the additional time will be charged at our standard hourly rates. S-Corps. can cost a little extra as there is additional paperwork with the S-Corp elections. $500 Upgrade Retainer Summer Promotion ($125 savings)

For online filings we use Business Filings Incorporated (BFI). They do excellent work! Click the above link and see the pricing chart for more information about your home state.

Our GTT Entity Formation Retainer includes much of what you need. Robert A. Green, CPA helps you decide if you need an entity and if so which one is best for you. Conversely, our competitors hard sell one of more cookie cutter entities to all who call on them; whether you need an entity or not. We design the right entity around your special tax needs (considering family, other work, and state issues) and execute it fast. Our independent attorneys prepare and review all the paperwork.

Our service is just what you need. Yes, you can form your own entity at your state Web site, or ask your local attorney to handle it all (probably at higher cost than our very competitive fee). But the most important issue is not simply forming an entity; rather it's forming an entity that's properly structured to take advantage of all the complex and nuanced trader tax strategies. We first consult you on these trader tax strategies, design the best entity and tax plan, and then help you execute it all with our customized entity formation service and annual tax preparation service (to collect those tax benefits). Overall, we save you a lot of money!

Our retainer fee includes the below services and login access:

Time with Robert A. Green CPA & CEO to discuss which entity is best suited for your needs and how to use it correctly to get all the tax benefits you are entitled to; while maintaining minimal costs in the entity.
Consultation on trader tax status and MTM in the entity versus you individually.
Entity tax structure planning and consultation.
Consultation on how to open a retirement plan in connection with your entity.
Consultation on how to avoid NASDAQ professional data feed fees is possible.
Consultation on how the entity interacts with your individual tax file (contributions, distributions, expenses, elections, accounting and more).
Online formation of entity at bfi (see above), with the key description you need;

Our independent attorneys take over from here and they prepare the standard legal paperwork:

Online application with the IRS for your tax identification number (EIN);
Preparation of resolutions to open trading account, mark-to-market elections and other related resolutions.
Preparation of entity paperwork including (simple and standardized) LLC Operating Agreement, or partnership agreement or corporate bylaws (for S or C-Corporations). These are very basic and generic for traders. Our attorneys can customize them further for your needs and also coordinate planning with your local legal counsel (for example with trust involvement).
For S-Corps, our CPAs prepare the S-Corp elections.

As you can see, our price includes a lot of valuable services. Few firms know a lot about trader tax status and MTM and when it comes to entities for traders, that's the whole ball game. Most of our entity formation customers go on to engage our firm for annual tax preparation, so we can make sure to deploy all our entity strategies correctly for maximum tax savings.

GTT Entity Formation login area. When you sign up for our GTT Entity Formation and Consultation Services, we give you login access.

Ready for help? Click here.


Entities are a good idea for traders in the following situations:

for late year mark-to-market (IRC 475) elections;
for part-time traders who just barely qualify for trader tax status and want to use a separate
entity tax return to reduce their chance of IRS questions (avoid problems for the Chen case);
to create earned income for the owner/manager in order to deduct health-insurance premiums and retirement plans (trading gains are not earned income, except for commodities dealers and traders registered on a commodities exchange);
sole proprietors can pay their spouse a fee to drive deductions for health-insurance premiums, retirement plans and other fringe benefits, but they can't pay themselves a fee (joint trading businesses are defacto general partnerships (in non-community property states and may choose to be as well in community property states); see the benefits of this below);
when you want to combine your trading capital with others in one pool of trading funds (proprietary trading firms, hedge funds and family partnerships). Caution, when you manage other people's money, you may trigger federal and/or state investment adviser and/or fiduciary care rules. Consult with an attorney first.

Nasdaq charges higher professional rates for market information for entities. Learn below how to qualify for non-professional rates.

Sole proprietors who are not licensed brokers are entitled to pay the lower "non-professional rates," and that can save you from several hundred to thousands of dollars per year, depending on what level of NASDAQ market information service you use. Our firm is working with NASDAQ to revise their definitions and allow entity traders who merely trade their own money to still qualify for the non-professional rates. We can cover this in your consultation. Click here to learn more. Find out from your broker if there are any savings or extra costs in having an entity account vs. an individual account.

Use "trader tax status" and the "trading rule" (a tax loophole) on the entity level to deliver business tax breaks to yourself and your investors:

Active traders/managers in hedge funds and other types of “trading” companies should learn how they can use “trader tax status” and the “trading rule” to deliver business tax breaks (including mark-to-market accounting, which acts as tax-loss insurance) to their investors. On our GTT Tax Strategies page, we explain our tax strategies using the "trading rule." GTT is the leading firm for showing business traders around the country how to use "trader tax status" for their own accounts. Now, we are showing traders how to set up hedge funds with trader tax status and take advantage of the "trading rule." Click here to learn more.

Ready for help? Click here.

Husband/wife general partnerships are similar to LLCs, but they cost less and can help you after-the-fact.

The below article by Robert A. Green, CPA, appeared in the July 2003 issue of Active Trader magazine: "I promise to love, honor and SAVE YOU TAX MONEY." Husband-wife partnerships require no formal agreement or paperwork, and they can save you a bundle on your tax returns.

Here is the original article submitted, before editing by the magazine. We have also added a few more points since the original publishing.

Note. If you are not married, you may be able to substitute another family member to have a family general partnership. Perhaps a parent, sibling or child. Just be careful about trading other people's money and triggering investment advisor and fiduciary care rules. Consult an attorney about this (we suggest GreenTraderLaw PLLC).

FOR BETTER OR WORSE!
Married traders can use a “husband/wife general partnership” to significantly improve their tax savings as well as provide for their retirement. Simply say “I do” and you don’t have to file any formal partnership agreement or other papers with your home state. You can even use this strategy to save money for prior tax years (in very limited cases, by filing amended tax returns – but you should consult with us first).

Being married is wonderful! One benefit for traders is that marriage can unlock some incredible tax savings strategies in connection with your trading business.

It is not necessary for your spouse to also be a trader in your business or otherwise “active,” according to IRS rules (click here). However, there are a few requirements:

You qualify for “trader tax status,” which means you operate a trading business (you trade every day, all day as a business activity); and

You have some or all of the below husband/wife trading business factors:
(i) your spouse is listed on your trading statements;
(ii) part of your trading capital belongs to your spouse; and
(iii) your spouse participates in your trading business, as a trader, manager or administrator.

If you think you meet some of these factors, consult with our firm. This area of the tax law is complex and a little vague.

Entities are beneficial
A good reason for forming a trader entity is it allows you to establish a retirement plan and/or other tax-deductible and tax-deferred employee benefit plans. These are not available for sole proprietor traders (who otherwise receive all trader tax status and MTM accounting benefits). Another good reason is that a trader entity can deliver business tax breaks to your spouse or investors. If you miss the April 15 MTM election, you can form an entity to elect MTM for the balance of the tax year.

Husband/wife trading “general partnerships” are ideal for many traders.
In the past, in order to have a husband/wife partnership, your spouse needed to be an integral part of your trading business. Your spouse also needed "trader tax status."

Exciting news! Our groundbreaking work on the "trading rule" (covered in detail here) means your spouse no longer needs trader tax status for the two of you to have a "general partnership" with all business tax breaks (i.e., business expenses and MTM ordinary gain or loss treatment).

The one exception is that if your spouse is “passive” in your trading partnership, he or she will be subject to "investment interest expense" rules (these are not a big deal).

Does your marriage cut the trading partnership cake?
Many traders list their spouse's name on their trading business brokerage accounts for various reasons – “joint tenancy”; in case one spouse dies; the money belongs to both spouses; or both spouses are in the trading business.

If your spouse is part of your trading business (a co-trader, manager or otherwise), the IRS does not allow a joint “sole proprietor” Schedule C (Profit of Loss from Business) filing. Instead, it requires you to report the trading business activity on a “general partnership” tax return (Form 1065).

Don’t be alarmed by this IRS tax rule clearly stated in the Schedule C instructions. It can be beneficial in many instances. The IRS does not require a formal partnership agreement or any filing whatsoever, except the partnership tax return. This is a “general partnership” for legal purposes and not a limited or other type of partnership. Other types of partnerships may require formal agreements and/or state filings.

Most states follow the federal rules and don’t have “minimum” taxes for general partnerships. Check with your home state, their Web site or with our firm. We have all the state rules and a nifty state table in our GTT Entity Formation login area.

In the case of a husband and wife trading partnership, the entire partnership activity ends up on the “married filing joint” tax return. The only difference is that instead of having a Schedule C for the trading business expenses and a Form 4797 for mark-to-market trading gains and losses, the entire trading loss (expenses and trading losses) is reported on your individual tax return Schedule E, page 2, Part II (Income or Loss from Partnerships and S-Corporations), Non-Passive Income and Loss section.

“New taxpayer” trading entities (never filed a tax return before) may elect mark-to-market (MTM) accounting by filing an “internal” resolution within 75 days of inception. If a spouse joins your trading business, you implicitly formed a partnership on the date he or she joined your business, and you have 75 days from that partnership inception date to elect MTM internally.

This can be beneficial to traders who missed the April 15 MTM election deadline. Their spouse can join their trading business and they can then elect MTM for this partnership after the April 15 date (assuming you start your partnership during the year). Be careful with this tax-beneficial strategy. If your spouse was part of your trading business from Jan. 1, you had to elect MTM by March 15.

In the case your spouse joins mid-year, split your trading business activity between Schedule C for the pre-partnership period and the partnership return afterwards. Use the cash method of accounting for the Schedule C period and the MTM method for the partnership return.

Community property states
In community property states there is a variation on the above IRS (Schedule C) rules.

The IRS allows joint Schedule C filings in community property states or a partnership return; it's the choice of the taxpayer.

There can be one snag in regards to the "defacto" period; the period before you formalize the partnership in writing. The IRS may treat you as a joint Schedule C rather than a defacto partnership, unless you claim you had a verbal partnership in place for the defacto period. This has significant consequences for claiming MTM earlier in the year.

Your spouse is listed as a joint tenant only
If your spouse is not part of your trading business, and you merely listed him or her on your trading brokerage statements (and Form 1099s) for joint tenancy reasons, that should not affect your “sole proprietor” trading business reporting on Schedule C.

Watch out, though. There can be complications. Assume you lose your spouse’s share of the trading account assets and your spouse is not part of your trading business. If you are using mark-to-market accounting, you may not use ordinary loss treatment for your spouse’s lost money. First of all, you don’t have basis; secondly, your spouse may not use MTM accounting. Rather, your spouse should take a “capital loss” for his or her share of the loss. You should consult with our firm for more help in this situation.

Your spouse is the only name on the trading accounts
If your spouse is not in your trading business, be careful not to list his or her name as the only name on your trading brokerage accounts. The IRS may prevent you from using trader tax status and MTM because the money belongs to your spouse. You should consult with our firm in this instance, as we have some clever solutions and fixes. One solution involves using a note payable to show that you borrowed the money from your spouse and it’s your money to gain or lose trading.

This husband and wife strategy is complex
If any of the tax returns are prepared incorrectly and don't have the correct footnotes, you are putting the tax benefits in jeopardy. We highly recommend that you engage us for a half-hour consultation. We will review your facts and circumstances and recommend the best way to proceed. We also recommend that you engage our firm to prepare your partnership and individual tax returns. It will be well worth our reasonable fees.

Caution – You are stuck with "built-in" capital loss.
Please note that when a partner contributes an asset to a partnership where the asset has a "built-in" capital loss in the hands of the partner (i.e., the cost basis of the asset is more than the fair market value at the date of the contribution to the partnership), the loss from sale of the asset is still treated as a capital loss by the partnership if the asset is sold within five years of the date it was contributed to the partnership. This is true even if the partnership has trader status and has properly elected MTM. Internal Revenue Code Section 724(c) specifically prevents the conversion of “built-in” capital losses on security transactions to ordinary losses by contributions from a cash basis investor to a trading entity that has properly elected MTM. This applies also to a LLC, including a single-member LLC. However, it does not apply to S-corporations.

An Example of a husband/wife trading partnership solution:
Joe and Nancy were happily married in 2001. Joe was a stock broker and Nancy a banker. In June of 2002, Joe wanted to pursue his dreams of being an entrepreneur and he left his job to start a trading business.

Joe opened a direct-access trading account with Terra Nova in 2002 and funded the account with some of his and Nancy’s capital.

They agreed that Nancy would help Joe manage the trading business, but that Nancy would not interfere with Joe’s day-to-day trading decisions. Nancy agreed to help with bookkeeping, strategy, risk assessment, and/or general business and finance issues.

Nancy insisted that her name be listed on the trading brokerage accounts, as a joint tenant, since some of the money was hers and if anything happened to Joe, she could immediately have access to these funds.

Unfortunately, their prior accountant did not inform them about mark-to-market (MTM) accounting or husband/wife partnerships.

On their 2002 individual income tax returns, their prior accountant treated Joe as a “sole proprietor” and reported trading business expenses, including margin interest expenses, on Schedule C (Profit or Loss from Business) for full ordinary loss treatment. These Schedule C losses offset Nancy’s W-2 wage income and generated a tax refund.

The bad news was that Joe and Nancy did not know about MTM; even if they did, it was too late to elect MTM in June 2002, when Joe started the trading business.

That's bad news, because Joe’s 2002 trading losses were $53,000 and their prior accountant limited them to a $3,000 capital loss limitation. Had Joe elected MTM by April 15, 2002 (with good planning), they could have deducted the entire $53,000 as an ordinary loss and received additional tax refunds of $20,000.

Their prior accountant put them into a tax predicament, as they had a capital loss carryover of $50,000 for 2003. He then compounded the error by skipping the MTM election for 2003. He did this because Joe had gains year-to-date in 2003, and the accountant figured by not electing MTM, he could offset 2003 capital gains with 2002 carryover capital losses. Had Joe elected MTM for 2003 (by April 15, 2003) and had gains for 2003, those gains would be ordinary gains and he could not deduct his capital loss carryover. As a result, they would increase his 2003 tax liabilities.

As it turned out, though, Joe ended up losing $43,000 more in trading for 2003, and the decision to not elect MTM was the wrong one. When Joe and Nancy visit their prior accountant for preparing their 2003 tax returns, he tells them the bad news. He tells them, "Tough luck. You can only deduct the $3,000 capital loss limitation, and you'll have to carry over a capital loss of $90,000 to 2004" ($50,000 from 2002 and $40,000 from 2003).

Well, we say "tough luck" to Joe and Nancy’s prior accountant. It's time for you to lose them as clients. They deserve better advice from a proven trader tax expert.

The fix for 2002
After speaking with our firm, it is decided that Joe and Nancy had a “defacto” general partnership for 2002 from the inception date of their trading business.

It is further determined that as “new taxpayers” (a new general partnership), Joe and Nancy verbally elected MTM accounting “internally” within 75 days of inception of their trading business.

Our firm then prepares and files an IRS Form SS-4 to get a tax identification number for their trading general partnership. They then file a late (but acceptable) general partnership tax return (Form 1065) for calendar year 2002, using MTM accounting. Late penalties are only $500.

Additionally, we prepare and file federal and state amended individual tax returns for 2002, reporting the partnership return Form K-1 ordinary losses (from trading losses and expenses) on Schedule E. The result of these new tax return filings are refunds of approximately $20,000 or more, depending on the marginal tax rates. Rather than having non-deductible capital losses, Joe and Nancy have full ordinary loss treatment on the $50,000 worth of trading losses for 2002.

The fix for 2003
Our firm prepares and files 2003 partnership and individual tax returns using MTM. The result is approximately $16,000 or more of additional tax refunds from a full ordinary loss on the $43,000 trading loss.

We prefer to file the 2003 partnership tax extensions by April 15, 2004, but if a client signs up with our firm after that date, we can still file "late" partnership tax returns with a small penalty. The penalty is $50 for each month or part of a month (for a maximum of 5 months) after the due date of the return (April 15, 2004), multiplied by the total number of partners in the partnership.

2004 tax planning
Joe turns it all around and as of mid-year 2004, he is on target to make about $200,000 trading in 2004.

Having the general partnership in place will afford Joe the opportunity to benefit from having a separate legal entity.

Joe plans to open a Mini 401(k) retirement plan and contribute and deduct up to $40,000 to that plan (Click here to learn more about these retirement plans). This retirement plan deduction will save Joe and Nancy several thousand dollars in taxes and provide Joe with tax-deferred retirement assets. Paying into social security and Medicare will also benefit Joe come retirement. If Joe was a sole proprietor, he could not establish a retirement plan.

Joe and Nancy get immediate tax refunds for all of their trading losses and are not stuck with 2004 capital loss carryovers of $90,000.

Note: Assuming Joe generates large trading gains in 2004, he could utilize $90,000 of capital loss carryovers from 2003 (assuming no fix herewith). It should be noted that many traders don’t turn it around like Joe and wind up with large capital loss carryovers they have little chance of ever recovering. Certainly, getting immediate refunds on ordinary trading losses with MTM is much better then hoping to generate capital gains in the future.

Bottom line: Take advantage of all the benefits of marriage, which include some tax benefits for traders. Assess your factors and consult with our firm. We can work with you to put some more positive factors in place. If you have a clear opportunity to file amended tax returns for immediate refunds, consider that strategy. Note that the IRS frowns on paying large tax refunds on amended tax returns, so you should carefully weigh all factors with us beforehand. Do not file these returns without us.

IRS rules: Here are some links and excerpts on the subject from the IRS Web site (www.irs.gov).

Employees – Other Employment Scenarios Husband and Wife Business. Click here.

Excerpt: Both spouses carrying on the trade or business

If spouses carry on a business together and share in the profits and losses, they may be partners in a partnership whether or not they have a formal partnership agreement. Spouses should report income or loss from the business on Form 1065, U.S. Partnership Return of Income. They should not report the income on a Form 1040 Schedule C, Profit or Loss From Business in the name of one spouse as a sole proprietor.

If each spouse is a partner in a partnership, each spouse should carry his or her share of the partnership income or loss from Form 1065, Schedule K-1, Partner's Share of Income, Credits, Deductions, etc., to their joint or separate Form(s) 1040. Each spouse should include his or her respective share of self-employment income on a separate Form 1040 Schedule SE, Self-Employment Tax. Self-employment income belongs to the person who is the member of the partnership and cannot be treated as self-employment income by the nonmember spouse, even in community property states. This generally does not increase the total tax on the return, but it does give each spouse credit for social security earnings on which retirement benefits are based. However, this may not be true if either spouse exceeds the social security tax limitation. Refer to Publication 553, Highlights of 2001 Tax Changes, for further information about self-employment taxes.

GTT Observation: The above explanation hints at what the IRS is after with "defacto" partnership treatment. The government’s goal is collecting more self-employment taxes to improve funding of social security and Medicare. Allocating net income between a husband and wife vs. just one of the spouses creates two rather than one "self-employment tax bases." This treatment also hints that the IRS will not be adversarial towards GTT's entities strategies, which create "earned income," thereby increasing the payment of self-employment taxes and retirement-plan contributions.

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General Information

If you trade securities and/or commodities as a business activity, you are entitled to many tax breaks. Business traders receive preferential “business tax” treatment vs. “investor tax” treatment (see details below).

A trader doesn’t have to form a separate legal entity, such as a partnership, corporation or limited liability company, to receive “business tax” breaks. If your trading activity rises to the level of business status, you are entitled to business tax breaks as a “sole proprietor” or “unincorporated entity.”

Conversely, forming a separate legal entity to conduct your trading activity without rising to the level of trading as a business will not entitle you to “business tax” breaks. In that case, you have an “investment entity” and must use “investment tax” rules (which have few breaks and many tax costs).

To receive business tax breaks in a separate legal entity, read our "GTT Tax Strategies" page. Click here.

An unincorporated trader needs an entity only if he or she wants to have a retirement plan and/or deduct health insurance premiums. Every profitable trader should have a retirement plan. Trading income is not "earned income," and thus is not able to be contributed to a retirement plan. So, you need an entity to pay you a salary, and the salary will be considered earned income. You then can set up a retirement plan and make annual tax-deductible contributions. The IRS recently increased the maximum annual amounts taxpayers are allowed to contribute, and this is a great tax savings area for traders. See our retirement plan page for more details.

Health insurance premiums: Self-employed taxpayers with "earned income" can deduct 100 percent of their health insurance costs in 2003 and beyond. This deduction is from "adjusted gross income" (AGI), which is a dollar-for-dollar deduction – just like ordinary business expenses are from gross income.

When it comes to entities for traders, the correct and best way happens to be the simple and easy way. We usually advocate a "pass-through" entity in your home state. Pass-through entities mean that your entity does not pay a tax; instead, gains, losses or expenses on the entity are passed through to your individual tax return to be taxed there. Pass-through entities file their own tax return and allocate income, gain, loss and expense to partners on a Form K-1.

We handle everything you need – consultation, formation, LLC Operating Agreements, start-up tax matters and your annual tax preparation. We stand by our work from beginning to end. The other firms charge you $3,000 for an ill-conceived multiple entity and, after they take your money, they don't answer your phone calls or do tax preparation – mainly because tax preparation doesn't work.

We can advise you on entities for money management, hedge funds and other investment vehicles. Click here to learn more about our hedge fund services. We can also show you ways to trade your family’s accounts without making things too complicated. We hope to hear from you soon.

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