April 15 tax extensions and Section 475 election

March 15, 2015 | By: Robert A. Green, CPA

Securities brokers issue corrected 1099Bs close to and sometimes even after the April 15 tax deadline due to complications over cost basis reporting. Schedule K-1s often come late, too.

When tax information is incomplete near the deadline, it’s wise to file an automatic six-month extension. Caution: It’s not a payment extension; so try to pay at least 90% of your tax liability to avoid late-filing and late-payment penalties. If you don’t pay 90%, hopefully the IRS will accept your “reasonable cause” spelled out in a letter seeking penalty abatement. Retaining tax funds as working capital for trading is not reasonable cause in my view.

April 15 is also the important deadline for individual and partnership traders qualifying for trader tax status to file a Section 475 MTM election statement with the IRS for 2015 and subsequent years. The election statement is attached to the federal extension.

There are many advantages to filing extensions. One negative is waiting longer for a tax refund, but traders often apply overpayment credits to estimated taxes due on trading income instead of claiming a refund.

Extensions for individuals
If you don’t owe taxes, the extensions are easy. Enter taxes paid (including credits) with the same amount for tax liability reflecting a zero balance due. Perhaps your spouse has a W-2 with ample tax withholding and you have trading business losses, itemized deductions and nominal other income. You don’t need to prepare detailed draft tax returns before April 15.

If you think you may owe taxes, then continue working on your tax filings. Prepare draft tax returns based on tax information in hand, accounting and estimates of missing information to generate the extensions from tax software. If you have year-to-date trading gains in 2015, it’s wise to be conservative with extension payments figuring you can apply overpayment credits toward 2015 estimated income taxes.

Extensions for entities
Tax extensions for pass-through entities are March 16, 2015 for S-Corps (since 15th is a Sunday) and April 15, 2015 for partnerships with an extension due date of Sept. 15. Pass-through entities are tax filers, not taxpayers, so the federal extension is simple to prepare without any tax liability. Be sure to file it on time because the late-filing penalty for missing the election is $195 per month per partner or shareholder up to a maximum of twelve months.

Some states have nominal franchise taxes or minimum taxes so check with your state or tax advisor. The state taxes are generally due with the extension filing. March 16 is also the deadline for an existing entity – LLC, C-Corp or general partnership (in most states) to elect S-Corp tax status (see our recent blog on S-Corps).

Section 475 MTM election
Active securities traders qualifying for trader tax status should consider a Section 475 MTM election for ordinary business loss treatment (tax loss insurance). Generally, you should elect Section 475 on securities only, not Section 1256 contracts so you retain lower 60/40 tax rates on those. Section 475 converts capital losses — otherwise subject to a $3,000 capital loss limitation and wash sales — into unlimited business ordinary losses. If you have large trading losses in 2015, you should consider a Section 475 election to lock in those losses as business ordinary losses. Ordinary losses are far better than capital losses.

If you have material capital loss carryovers, you can form a new trading entity to pass-through capital gains to your individual tax return, thereby using up capital loss carryovers. In the last-minute rush of tax season, many taxpayers and tax preparers make the wrong decision on Section 475 and it costs them thousands of dollars in tax savings.

Existing partnerships and individuals elect Section 475 for 2015 by attaching an election statement to their 2014 federal extension filed by April 15, 2015. For existing S-Corps, the election date is March 16, 2015. The second step is to file a Form 3115 (Change of Accounting Method) with your 2015 tax return filed in 2016. Learn more about Section 475 and see the election statement in Green’s 2015 Trader Tax Guide. Consult a trader tax expert before the election deadline.

Broker 1099Bs and confusion over wash sales
Many securities brokers are issuing corrected 1099Bs — it’s the new normal. Brokers continue to face many challenges with new IRS cost-basis reporting rules, including wash sale loss adjustments.Options and simple debt instruments purchased on or after Jan. 1, 2014 are considered “covered securities” and are included on 2014 Form 1099Bs for the first time.

Broker and taxpayer rules differ on calculations for wash sales. Brokers calculate wash sales based on the same equity or symbol (identical position) per account. Conversely, taxpayers must calculate wash sales based on substantially identical positions — i.e., between stocks and stock options and options at different expiration dates — across all individual accounts including all IRAs, even Roth IRAs.

Taxpayers can’t rely on 1099Bs and profit and loss reports from brokers if they trade securities and options or have multiple accounts. In these cases, taxpayers should use securities trade accounting software like TradeLog, which calculates wash sales correctly based on substantially identical positions across all accounts. It’s important to reconcile TradeLog results to 1099Bs, so taxpayers need to account for corrected 1099Bs on tax filings. TradeLog and other software publishers release program updates late in tax season or after April 15, too.

Traders are not simple like employees
Employees have taxes withheld on each paycheck and many wind up over-withheld generating material tax refunds, which they are anxious to collect. Many employees have simple tax filings and they can file early. Don’t wait for tax refunds every year — update your W-4 for more allowances and less tax withholding. Traders don’t have tax withholding on trading income. They generally owe taxes on trading income on April 15 because many prefer to underpay estimated taxes.

Traders with large Section 475 ordinary losses may be due large tax refunds. These traders have a lot riding on trade accounting and trader tax status; they should not rush their tax filings, especially if corrected 1099Bs are expected. Rushing may lead to errors, delays in tax refunds and potential tax exams, which can hold up refunds.

Futures and forex traders
If you trade Section 1256 contracts (futures), your broker issues a simple one-page 1099-B listing “aggregate profit and loss” based on marked-to-market accounting (realized and unrealized gains and losses). Correct 1099-Bs are rare for Section 1256 contracts. Likewise, forex brokers provide an online tax report that is reliable.

Extensions provide benefits for retirement plans
2014 contributions to Individual 401(k), SEP IRA and employer 401(k) profit-sharing plans must be funded by the due date of your tax return — Oct. 15 if you filed for an extension. That helps your cash flow. But IRAs must be funded by the original due date of April 15.

If your 2014 Roth IRA conversion didn’t work out well — perhaps the securities dropped significantly in value and you paid conversion taxes on the higher value — you’re entitled to “re-characterize” (reverse) the Roth IRA conversion up until the extended due date of Oct. 15. If you already filed your 2014 tax return, you’ll have to amend it to reflect the re-characterization.

Pressuring your tax preparer may lead to errors
If you engage a quality CPA firm for tax compliance, you should not expect them to focus on completing your tax returns during the last few weeks of tax season when filing an extension is a better option. Quality firms have internal deadlines and they avoid error-prone working conditions. I’ve seen countless cases of clients coming to us with botched prior year tax returns where they also missed vital tax elections like Section 475 because they focused on filing a complete return rather than filing an extension and making this election.

Early filers may get audited more
“The early bird gets the worm.” But in this case, the IRS is the bird and your tax return may be the worm selected for audit. I’ve always believed that audit quotas are met based on early filers. The IRS also wants to get started early with exams, and not wait until Oct. 15.

At the start of tax season, the IRS commissioner said there would be delays due to complications over Obamacare taxes, late renewal of “tax extenders” and the IRS being short of resources and staff.

Late-filing and late-payment penalties
Read federal automatic extension Form 4868 with instructions, especially the Page 2 sections on late-filing and late-payment penalties and how to avoid them.

State extensions
Some states don’t require an automatic extension if you’re overpaid and they accept the federal extension. Generally in all states, if you owe taxes, you need to file a state extension with payment. States tend to be less accommodating than the IRS in waiving penalties, so it’s usually wise to cover your state first if you are short on cash. Check the extension rules in your state.

U.S. citizens and resident aliens abroad
Excerpt from the IRS website: “If you are a U.S. citizen or resident alien residing overseas, or are in the military on duty outside the U.S., on the regular due date of your return, you are allowed an automatic 2-month extension to file your return and pay any amount due without requesting an extension. For a calendar year return, the automatic 2-month extension is to June 15. If you qualify for this 2-month extension, penalties for paying any tax late are assessed from the 2-month extended due date of the payment (June 15 for calendar year taxpayers). However, even if you are allowed an extension, you will have to pay interest on any tax not paid by the regular due date of your return (April 15 for calendar year taxpayers).” 

 

 


Business traders maximize tax benefits with an S-Corp

March 6, 2015 | By: Robert A. Green, CPA

S-Corp elections are due by March 15, 2015 for existing entities.

Forming an entity taxed as an S-Corp can save active business traders significant taxes. With an S-Corp, business traders solidify trader tax status, maximize employee-benefit deductions (such as health insurance and retirement plan deductions) and gain flexibility with a Section 475 election.

Tax returns are simple
An S-Corp tax return consolidates your trading activity on a pass-through tax return making life easier for you, your accountant and the IRS. Pass-through means there’s no federal tax on the entity level, which avoids double taxation in C-Corps. (Read our recent blog on corporations.) The S-Corp Form 1120-S reports trading gains, losses and expenses, including officer compensation and profit-sharing plan contributions.

Better than a sole proprietorship
The first tax benefit is business expense treatment (Section 162) rather than restricted investment expense treatment (Section 212). If the S-Corp qualifies for trader tax status, it has business expense treatment; otherwise it’s an investment company with investor tax status. The S-Corp tax return looks better than a sole proprietorship trading business Schedule C. The S-Corp shows all activity, whereas a Schedule C only shows business expenses — with trading gains reported on other tax forms — and that looks like a losing business to the IRS. Business expense treatment saves traders more than $5,000 per year in taxes vs. investment expense treatment.

Sole proprietor business traders cannot have employee-benefit deductions in connection with trading gains. Plus, a sole proprietor cannot pay himself a salary or fee to generate self-employment income (SEI) or earned income, which is required for AGI deductions including health insurance and retirement plans. Those employee-benefit plans can save business traders between $3,000 to $17,000 or more per year if properly arranged with an S-Corp structure.

Better than a partnership tax return
Traders need an entity to financially engineer earned income for health and retirement plan deductions. The S-Corp is better than a partnership tax return for this.

Partnership tax returns are inefficient for employee-benefit plan deductions. Partnership tax returns pass through expenses and net losses for income tax and self-employment income tax — the latter being a problem. The partnership pays a guaranteed payment or administration fee to the owner/trader to create SEI. But after the partnership passes through SEI losses, the net result is a low amount of SEI, which constricts a retirement plan contribution.

It works differently with an S-Corp. The S-Corp pays the owner/trader compensation reported on a W-2. The S-Corp passes through expenses and losses for income tax purposes, but not for SEI tax purposes. Employee-benefit plan deductions are entirely based on the amount of W-2 wages and there’s no reduction of earned income from S-Corp expenses and losses. That key difference unlocks the ability to maximize retirement plan contributions.

Tax planning
The owner/officer can have a base salary for covering the health insurance premium deduction, which is allowed even if the S-Corp has trading losses. If the S-Corp has sufficient trading profits by Q4, establish a retirement plan before year-end. Start with the 100% deductible employer 401(k) elective deferral ($17,500 for 2014 and $18,000 for 2015) and pay it before year-end through payroll since it’s reported on the annual W-2.

If you have large trading gains, increase payroll in December for a performance-based bonus to unlock a 25% employer 401(k) profit-sharing retirement plan contribution. You don’t have to contribute into the plan until the due date of the tax return (including extensions). The maximum defined-contribution profit-sharing plan amount is $52,000 plus $5,500 catch-up for 2014, and $53,000 plus $6,000 catch-up for 2015. (For details about retirement plan choices, limits and savings, see Green’s 2015 Trader Tax Guide Chapter 8.)

S-Corp elections
Existing LLCs, C-Corps and general partnerships may elect S-Corp treatment in every state except general partnerships in Connecticut, the District of Columbia, Michigan, New Hampshire, New Jersey and Tennessee. File a S-Corp election on IRS Form 2553 by March 15, 2015. The effective date of the election is January 1, 2015. Most states accept the federal election; if not, file an election in your home state, too. If you miss the S-Corp election deadline, there is IRS and in some cases also state relief for late filings. You’ll need a perjury statement stating you intended to file the election on time. Existing corporations cause taxation on converting accumulated retained earnings.

A new entity may elect S-Corp treatment within 75 days of inception.

Other rules
If you use an S-Corp, read Green’s 2015 Trader Tax Guide Chapter 7 on important issues including officer’s reasonable compensation, stock and debt basis, accounting allocations and more. Underlying income from a trading business is not earned income, so IRS reasonable compensation rules do not apply.

Bottom line
If you’re interested in making an S-Corp election, contact your tax advisor well before the March 15 deadline. There’s still plenty of time to set up a new S-Corp after March 15 to generate employee benefit plan deductions before year-end.

 


C-Corps have limited use for tax savings

February 26, 2015 | By: Robert A. Green, CPA

A C-Corp can help upper-income taxpayers in business save taxes, but it’s not useful to investors.

Increasingly, upper-income folks and their tax professionals are considering a corporate structure in tax planning in order to avoid Obama-era tax hikes. Starting in 2013, Congress raised the top tax bracket for individuals to 39.6% — effectively 41% after factoring in the Pease itemized-deduction limitation. When the 3.8% Net Investment Tax on unearned income is factored in, the combined individual top rate is a hefty 45%. Upper-income taxpayers are rewarded with an 11% or more tax savings when they can shift income from their individual to corporate tax returns. Plus, Congress is discussing corporate tax reform and they may reduce corporate rates widening the gap with individual rates.

Active traders who don’t qualify for trader tax status (business treatment) wonder if a corporate structure allows trading expense deductions considering that Section 212 investment expenses are restricted on individual tax returns. Corporations cannot deduct Section 212 investment expenses; therefore they don’t provide tax relief when a trader does not qualify for trader tax status.

Businesses can efficiently shift income to a corporation
A pass-through-entity trading business – like an LLC or S-Corp – qualifying for trader tax status has business expense treatment. Administration fees paid to a management company organized as a corporation are a business deduction on the pass-through entity. The receiving corporation has business income and expense treatment.

Business treatment on both the pass-through entity and corporation translates to tax efficiency.

Investors cannot efficiently shift income to a corporation
A pass-through-entity investment company has Section 212 investment expense treatment on the individual owner’s level for administration fees paid to a management company organized as a corporation.

That’s not tax efficient since investment expenses face significant limitations on individual tax returns, including the 2% AGI threshold for miscellaneous itemized deductions and the Pease itemized deduction limitation. Miscellaneous itemized deductions are not deductible for AMT tax.

If the investment company allocates a share of trading gains to the management company corporation in lieu of paying fees, the corporation doesn’t have business purpose. Plus, the corporation could be deemed a personal holding company (PHC) subject to a PHC surtax of 20% on undistributed PHC income. A corporation may not deduct non-business expenses including Section 212 investment expenses, which only individuals may deduct.

Corporations deduct business expenses, not investment expenses
Corporations with business activities may deduct Section 162 trade or business expenses. Corporations aren’t permitted to deduct non-business expenses including Section 212 investment expenses for individuals. When a corporation with established trade or business has ancillary investment expenses related to their business activities — like investing working capital — those expenses are deemed Section 162 business expenses and not Section 212 investment expense. Pure investment companies structured as a corporation may not deduct investment expenses. Pass-through entities with investor tax status report investment expenses on Schedule K-1 issued to individual owners.

Tax law is clear
Our CPA firm researched this tax law: It’s clear Section 212 is for individuals only, and corporations need business purpose to deduct Section 162 business expenses. Corporations cannot deduct non-business expenses. I spoke with an IRS official on this matter and his informal advice was to agree with the position stated in this blog.

Here are some excerpts from highly respected tax publication Bittker and Eustice on “Corporate Deductions.”

  • “The Code allows individuals to take a number of deductions that are not allowed to corporations, including the standard deduction, (investment expenses)…. (the code) prevent restrictions aimed primarily at individuals from being sidestepped by a transfer of the restricted activities to a closely held corporation…Section 212 is restricted to individuals, however, presumably on the theory that § 162(a) covers the same ground for corporations that § 162(a) and 212 in combination cover for other taxpayers. Thus, if a corporation engaged in manufacturing holds some securities as an incidental investment, the cost of a safe-deposit box, investment advice, bookkeeping, and so forth incurred with respect to the securities would be deductible under § 162(a) as trade or business expenses, even though an individual proprietor holding such securities would have to resort to § 212 as authority for deducting such expenses.”

Warning to traders not qualifying for trader tax status
Traders not qualifying for trader tax status should not use a corporation since they don’t have business purpose and corporations can’t deduct non-business expenses. While a corporation starts off with presumption of business purpose, that alone doesn’t achieve business purpose. The corporation must qualify for a trade or business. For a trader that means qualification for trader tax status. A corporation is not a remedy for not qualifying for trader tax status.

Corporate tax rates are materially lower than individual rates
The corporate tax rate starts at 15% on the first $50,000 of income, 25% on the next $25,000 and it settles in at 34% thereafter. Personal service companies don’t qualify for the lower rates under 34%. Taxpayers generally try to take advantage of the lower bracket rates so if the corporation pays them qualified dividends years later there’s still meaningful cumulative tax savings.

Unlike pass-through entities including S-corps, LLCs and partnerships, a corporation (C-Corp) pays entity-level taxes. (Note: LLCs can also elect C-Corp tax-filing status.) An individual owner pays taxes on qualified dividends paid by the corporation up to a 20% (long-term capital gains) rate. Plus a 3.8% NIT is applied on unearned income if you’re over the AGI threshold. Paying taxes on the entity and individual levels is commonly referred to as “double taxation.” Corporations avoid double taxation by paying compensation to owner/officers. Most states also tax corporations, so double taxation can defeat the purpose of using a corporation in high tax states. (State taxation for corporations is beyond the scope of this blog post; see more information in Green’s 2015 Trader Tax Guide.)

A corporation needs business purpose
Before you jump into reorganization as a corporation, it’s important to understand the pros, cons and potential pitfalls. My bailiwick is investors, traders and investment managers. In a nutshell, adding a corporation as a second entity makes sense for a business trader or investment manager to reduce Obama-era tax hikes on individuals. But using a C-Corp structure for an investment company does not work. Corporations need a business purpose; therefore, investors won’t find salvation using a corporate structure.

A successful strategy for a trading business
Suppose you have a successful trading company LLC that qualifies for trader tax status and files as either a S-Corp or partnership. Consider adding a corporation as a second entity to provide administration services or to hold intellectual property and charge royalties to the trading company LLC. That has the effect of shifting income from your individual tax return to a corporate tax return. Either the S-Corp trading company or C-Corp management company can unlock employee-benefit plan deductions including health insurance and retirement plans. (Investment companies can’t generate compensation or earned income by arranging employee-benefit plan deductions.)

A failed strategy for an investor
Suppose you have an investment activity that doesn’t qualify for trader tax status (business treatment). (Read How to Qualify.) You also don’t offer investment management services to clients, so you don’t have any business purpose.

A tax salesman approaches you and promises tax deductions using a corporation. These promoters find their prey on the trading education and seminar circuit. The promoter says you can dump your education expenses and other startup expenses into a corporation going 18 months back and generate a net operating loss (NOL) in the corporation to carryover to subsequent tax years. The promoter also suggests a second LLC entity for trading.

If that LLC doesn’t qualify for trader tax status and pays the corporation management or administration fees, it will have investment expense treatment. That defeats the purpose and you’re right back at the beginning of the problem with investment expense limitations on your individual tax return. Seminars and pre-business education are generally not deductible as investment expenses pursuant to Section 274(h)(7).

Conversely, the LLC can wait to achieve trader tax status at a later date and pay the corporation fees then, which will be business deductions for the LLC trading business. The promoters argue the corporation can utilize its NOL to offset the income from the trading business LLC. But, that doesn’t work in my view, as the corporation can’t deduct those expenses in the first place without business purpose from its inception. Dumping expenses that lack deductibility into a corporation for later use does not have legal authority.

At best, the corporation is entitled to capitalize Section 195 startup business expenses for a reasonable amount over a reasonable period if it has business purpose in the works. It’s simple for an IRS agent to determine whether a corporation has trader tax status or business revenue and, therefore, to determine whether any expenses are legitimate Section 162 corporate deductions.

Personal holding company taxes
Corporate structures are intended for trade or business, not investment companies. Personal holding company (PHC) law charges additional taxes on corporations straying into non-business activities. There are exceptions from PHC rules for financial institutions including banks and insurance companies, but that list doesn’t include trading companies.

The PHC tax is 20% of undistributed personal holding company income. PHC income (Section 543) includes dividends, interest, royalties (with exceptions), annuities, rents, personal service contracts (with exceptions) and more. Exceptions from PHC income include active business computer software royalties, active business copyright royalties in many fact patterns and personal service contracts when a specific person (talent) isn’t named in the contract (consult a tax expert). PHC income also does not include capital gains on trading, which is the main source of income in a trading company. PHCs are corporations with five or fewer owners and more than 60% of their income is from PHC income. The definition of PHC Section 542 discusses business deductions and it clearly leaves out Section 212 investment expenses (which are for individuals not corporations).

Bottom line
The tax code is written to prevent individuals from skirting the narrow Section 212 investment expense deduction rules. Schemes to dump these expenses into corporations are poorly conceived and will lead to tax trouble.

Business traders and investment managers paying top Obama-era tax rates should consider adding a corporation to the mix for legitimate tax savings.

Green NFH CPA Darren Neuschwander and tax attorney Roger Lorence contributed to this blog.

 


9 good reasons to engage Green NFH for tax preparation

February 23, 2015 | By: Robert A. Green, CPA

Traders have unique tax needs requiring a specialist. Here are nine good reasons to engage our firm for your 2014 federal and state income tax return preparation. Tax compliance including preparation and planning is our core business and we have excellent long-term relationships with our valued clients.

  1. Large trading losses

Filing a tax return with large trading losses reported as ordinary losses causes IRS concern about paying large refunds. The IRS is accustomed to capital loss imitations. Forex traders with the default Section 988 treatment have ordinary losses. Active securities traders qualifying for trader tax status (TTS) and using a timely filed Section 475 election also generate business ordinary losses and net operating loss carryback refund claims. If you’re counting on a large refund or tax benefit from deducting ordinary trading losses, you should have our firm prepare and sign your tax return.

  1. Trader tax status and related tax benefits

The IRS doesn’t fully understand TTS and it’s important to file your tax return without red flags and include good written explanations in tax return footnotes. Many self-preparers and local accountants botch TTS reporting strategies, missing tax benefits and reporting items incorrectly. Taxpayers must properly elect Section 475 on time and perfect the election with a correctly filed Form 3115. The linchpin to trader tax benefits — business expenses, Section 475, and employee-benefit plans with entities — is qualification for TTS and our CPAs are highly trained in analyzing your qualification.

  1. Entities and retirement plans

Traders need to create compensation correctly to unlock and maximize employee-benefit plans including health insurance and retirement plans. Home office and other unreimbursed expenses need to be reported properly on individual returns in relation to entity income passed through on Schedule K-1. Pitfalls need to be avoided with C-Corps.

  1. Wash sales and Form 8949

Active securities traders generate many wash sale loss adjustments and brokers don’t report wash sales according to IRS rules for taxpayers. Taxpayers must make many changes on Form 8949 and they also must reconcile Form 1099Bs and explain differences in footnotes.

  1. Forex traders using lower 60/40 tax rates

We make a case for filing a capital gains election on spot forex to get lower Section 1256(g) 60/40 tax treatment. But those rules are vague and uncertain. If you’re reporting large forex trading gains with lower 60/40 tax rates, it’s wise to have our firm prepare and sign your tax return.

  1. Trading many different financial instruments

Tax treatment varies significantly among different types of financial instruments including securities, options, 1256 contracts, ETFs, indexes, forex, Nadex binary options, swaps, precious metals, bitcoin, and other financial products. It’s not always clear how a financial instrument is taxed and some brokers don’t get it right. Our CPAs look over your financial instruments to identify errors in tax treatment.

  1. Maximize expense deductions

Our CPAs are focused on maximizing deductions for investors, business traders, and investment managers. Where, how, and what expenses to deduct depend on your tax status. We handle thousands of traders and see every type of deduction possible — we won’t miss any for you.

  1. Obamacare net investment tax (NIT)

If you’re over the AGI thresholds for NIT — $250,000 married and $200,000 single — it’s important to reduce 3.8% NIT as much as possible. Many accountants don’t understand the nuances of NIT for traders. For example, unlike other taxpayers, Section 475 traders may offset trading losses against other bucket income getting a better result. Traders can also reduce NII by trading and investment expenses.

  1. Convenience and excellent service

Investor, trader, investment management, and small business tax compliance is complex and nuanced. Self-preparers will spend countless hours trying to get it right and they will probably get it wrong. Local CPAs, accountants and tax storefronts are known to botch tax return planning and preparation for investors, traders, and investment managers. We have endless stories of traders missing vital tax elections like the contemporaneous forex capital gains election or the Section 475 MTM election due by April 15, 2015. Our virtual service is very convenient and we maximize every legal tax benefit while avoiding tax trouble and pitfalls. We utilize best practices and technologies with our highly trained CPAs for excellent communication, work product, and client satisfaction. We have the best client testimonials and media and trading industry endorsements by far. Or tax preparation prices are very competitive and they represent a great value when you factor in tax savings and avoidance of tax trouble. Plus our fees are tax deductible, often as a business expense. We guarantee that you will be pleased with our service!
Tax return or extension due dates are coming up: March 15 for S-Corps and April 15 for individuals and partnerships. Visit our tax compliance section to get started.

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We recommend our Tradelog accounting service for active securities traders with wash sales who don’t want to operate Tradelog on their own.

Please tell us about your 2014 tax file (via email, Website contact form, or chat) so we can provide a price estimate. For a limited time, you may also schedule a 15-minute session with Managing Member Darren Neuschwander CPA to discuss how you can benefit from our service and for a price estimate. Click here.

We hope to hear from you soon. Don’t wait until the last minute, as we likely won’t be able to accommodate you then. Thanks for considering our services.

Sincerely,
Robert A. Green, CPA
Darren L. Neuschwander, CPA
Managing Members of Green NFH LLC

 

 


Frequently Asked Questions (FAQs) on Trader Tax

February 19, 2015 | By: Robert A. Green, CPA

How are securities taxed?
Securities traders need to watch out for higher tax rates, wash sales, capital-loss limitations and accounting challenges. Realized transactions in securities are reported trade by trade (or line by line) on Form 8949, which feeds into Schedule D where short- and long-term capital gains rates apply. Click here to see what’s included in securities and to learn more. Visit the Tax Treatment section for tax guidance on all sorts of trading instruments.

How should I handle wash sales on securities?
See our separate FAQs on wash sale losses.

How are Section 1256 contracts taxed?
Section 1256 contract traders enjoy lower 60/40 tax rates, summary reporting, and no need for accounting. (The 60/40 rates mean 60% is taxed at the lower long-term capital gains rate and 40% is taxed at the short-term rate, which is the ordinary tax rate.) Section 1256 contracts are marked-to-market (MTM) on a daily basis and reported on Form 6781. MTM means you report both realized and unrealized gains and losses at year-end. Click here to see what’s included in Section 1256 contracts and to learn more.

What is Section 475 and can that election help me?
Section 475 MTM allows qualifying business traders to deduct trading losses in the current tax year as ordinary business losses, without capital loss limitations or wash sale loss adjustments. Short term capital gains are taxed at the ordinary rate, so taxes are the same on trading gains, but Section 475 is much better on trading losses — we call it “tax loss insurance.” GreenTraderTax recommends Section 475 for securities, but not for Section 1256 contracts where you would otherwise forgo lower 60/40 tax rates. Click here to learn more about Section 475.

Can you request a 1099B based on using Section 475?
Brokers are supposed to prepare Form 1099Bs for the everyman, not based on a taxpayer’s election or other facts and circumstances. How can a broker know for sure that a trader elected Section 475 on time and or is entitled to use Section 475, which is conditional on qualifying for trader tax status?

Can I deduct my trading-related expenses on my tax return?
Deductibility is based on tax status: whether you qualify for trader tax status (business treatment) or must use the default investor tax status (investment treatment).

Individual investors are permitted to deduct Section 212 investment expenses related to the production of investment income. Investment expenses exclude home-office, education, and Section 195 startup costs. There are many limitations for investment expenses, deductible as miscellaneous itemized deductions on Schedule A including the 2% AGI threshold, Pease limitation, listed property rules, and AMT preferences.

Business traders qualifying for trader tax status are able to deduct all trading expenses, including home office, education, and Section 195 startup costs, from gross income. Sole proprietor traders report business expenses (only) on Schedule C, and trading gains and losses are reported on other tax forms. An election is not required for claiming business expense treatment. Click here to learn how to qualify for trader tax status. Click here to learn more about business expense treatment.

Are brokerage commissions tax deductible?
Yes, but they are not separately stated tax deductions. Rather, commissions are part of your trading gain or loss — an adjustment to proceeds and cost-basis.

Do I need to fill out a Form 8949 for my securities trades?
Casual investors might have no wash sale adjustments or other cost-basis adjustments and just one securities brokerage account with a few equity transactions. They may qualify to attach their 1099B and skip inclusion of a Form 8949. Active traders won’t qualify for this short cut.

The cost-basis rules are almost fully phased in. Options and less complex fixed income securities acquired on Jan. 1, 2014 or later are reportable for the first time on Form 1099-Bs for 2014. Click here to learn more about IRS cost-basis reporting and Form 8949.

Is there software that can help with Form 8949?
Yes, GreenTraderTax and Barron’s recommend Tradelog software. Tradelog’s website has more resources on wash sales and issues raised on different brokers’ 1099Bs.

Where can I learn more about trader tax matters, including entities, retirement plans, Obamacare taxes, compliance tips, and more?
In Green’s 2015 Trader Tax Guide.

I prepared these FAQs for an online broker catering to active securities traders. 

 


Frequently Asked Questions (FAQs) on Wash Sale Losses

| By: Robert A. Green, CPA

Wash sale losses are a major source of confusion for taxpayers and brokers come tax time, so we answered several FAQs to help.

What’s the best solution for reporting wash sale losses correctly?
Trader tax accounting software that downloads all purchase and sale transaction history and calculates wash sale losses according to taxpayer rules recapped below. In most cases, taxpayers can’t rely on 1099Bs or broker profit and loss reports for reporting wash sales. GreenTraderTax and Barron’s recommend Tradelog software to calculate wash sales across all your accounts and for generating a correct Form 8949. You need to reconcile Form 8949 to 1099Bs and explain the differences as best you can. Click here to learn about GreenTraderTax’s accounting service for securities traders.

What are wash sale losses?
Per IRS Pub. 550, “A wash sale occurs when you sell or trade stock or securities at a loss and within 30 days before or after the sale you: buy substantially identical stock or securities; acquire substantially identical stock or securities in a fully taxable trade; acquire a contract or option to buy substantially identical stock or securities, or acquire substantially identical stock for your individual retirement account (IRA) or Roth IRA.”

The IRS wash sale loss rules (Section 1091) are written to protect the U.S. Treasury against taxpayers taking “tax losses” at year-end to lower tax bills while they get right back into the same positions. The IRS views that as a tax loss but not an economic loss and much of the tax code prevents that from happening.

Wash sale loss adjustments defer losses to the subsequent tax year, where a taxpayer hopefully can utilize that loss. However, if you trigger a wash sale loss with an IRA, you permanently lose the wash sale loss.

Do I have to account for wash sale losses?
Yes, if you trade securities including equities, equity options, ETFs, narrow-based indices (made up of nine or fewer securities), and bonds. Click here to learn more about securities.

What’s exempt from wash sale losses?
Wash sales do not apply to Section 1256 contracts including futures, broad-based indices, and options on futures since they are marked-to-market (MTM). That’s economic reporting and there’s no way to defer wash sale losses. Click here to learn more about Section 1256 contracts.

Business traders with a Section 475 MTM election are exempt from wash sale loss reporting on their business trading positions. Consider a timely 2015 Section 475 election to convert 2014 wash sale loss deferrals on business positions into ordinary losses on Jan. 1, 2015. Click here to learn more about Section 475. Existing individuals and partnerships must file a Section 475 election by April 15 and S-Corps by March 15.

Where do I report wash sale loss adjustments?
Report wash sale loss adjustments on Form 8949 (instructions), along with other cost-basis reporting. Learn more about cost-basis reporting in the Green Trader Tax Center.

Do brokers report wash sale loss adjustments on Form 1099B?
Yes, but in compliance with IRS rules for brokers which differ from IRS rules for taxpayers. In most cases, taxpayers need to do additional work on wash sale loss reporting.

How do broker and taxpayer rules differ on wash sales?
Brokers calculate wash sales based on identical positions (an exact symbol only) per brokerage account. Section 1091 requires taxpayers to calculate wash sales based on substantially identical positions (between stocks and options and options at different exercise dates) across all their accounts including IRAs — even Roth IRAs.

What is a substantially identical position?
Apple stock and Apple options are substantially identical, but Apple stock and Google stock are not substantially identical.

Are options subject to cost-basis reporting and wash sale loss adjustments?
Yes, IRS cost-basis reporting rules phased-in options purchased on or after Jan. 1, 2014. Brokers won’t report a wash sale loss between a stock and an option, but taxpayers must do so. Options at different expiration dates have different symbols, so they are considered substantially identical.

Can I rely on my 1099-B for reporting wash sale loss adjustments?
Only if you have one brokerage account trading equities. If you trade stocks and stock options, or just stock options and/or have multiple brokerage accounts, you can’t rely on brokerage firm Form 1099-Bs for reporting wash sale losses correctly because there will be differences in application of taxpayer rules on substantially identical positions.

Are brokerage firm profit and loss reports similar to 1099Bs?
Yes, brokers use the same accounting for the 1099B and their profit and loss reports. When brokers suggest downloading a 1099B into TurboTax, they really mean downloading their profit and loss report. Those P&L reports account for wash sales based on broker rules, not taxpayer rules.

Do I have to worry about my IRA accounts in my wash sale loss calculations?
Yes, as recapped in IRS Pub. 550 above, Section 1091 includes all types of IRAs. It’s a catastrophic mistake to trigger a wash sale loss in your IRA since you will never get that tax loss benefit as it won’t reduce distributions in retirement for a traditional IRA. It’s wise to avoid trading substantially identical positions between an IRA and your taxable accounts.

What accounts are included in the wash sale loss analysis?
It goes by taxpayer identification number, so consider an entity with a separate taxpayer ID for your active trading to divorce that trading from your IRA and individual taxable accounts for wash sale loss calculations. If you are married filing joint, make sure to include each spouse’s separate, joint, and IRA accounts.

Where can I learn more about wash sales?
Read the GreenTraderTax blog “How will you handle wash sale losses on securities this tax season?” and watch the related Webinar recording.

I prepared these FAQs for an online broker catering to active securities traders. 


How will you handle wash sale losses on securities this tax season?

January 23, 2015 | By: Robert A. Green, CPA

If you actively trade equities and equity options and or securities in more than one account, unless you use proper software on all your individual taxable and IRA accounts, you will probably handle wash sales wrong and under-report or over-report your taxable income. In these cases, you can’t rely on 1099-B reporting because brokers use a different set of tax compliance rules than taxpayers in calculating and reporting wash sale losses.

The IRS cost-basis reporting saga continues
Accounting for trading gains and losses is the responsibility of securities traders; they must report each securities trade and related wash-sale adjustments on IRS Form 8949 in compliance with Section 1091, which then feeds into Schedule D (capital gains and losses). Form 8949 came about after the IRS beefed up compliance for securities brokers starting in 2011, causing headaches, confusion and additional tax compliance cost. Congress found tax reporting for securities to be inadequate and thought many taxpayers were underreporting capital gains. The cost-basis rules are almost fully phased-in. Options and less complex fixed income securities acquired on Jan. 1, 2014 or later are reportable for the first time on Form 1099-Bs for 2014. Inclusion of complex debt instruments on 1099-Bs is delayed until Jan. 1, 2016.

Broker-issued securities Form 1099-Bs provide cost-basis reporting information, but they often don’t provide taxpayers what they need for tax reporting. For example, brokers calculate wash sales based on identical positions (an exact symbol only) per separate brokerage account. But Section 1091 requires taxpayers to calculate wash sales based on substantially identical positions (between stocks and options and options at different exercise dates) across all their accounts including IRAs — even Roth IRAs.

Taxpayers report securities proceeds, cost basis, adjustments, holding period and capital gain or loss – short term vs. long-term (held over 12 months) on Form 8949. According to the form’s instructions, taxpayers without wash sale and other adjustments to cost-basis may simply enter totals from broker 1099-Bs directly on Schedule D and skip filing a Form 8949. After all, the IRS gets a copy of the 1099-B with all the details.

But, there is a protracted ongoing problem for many taxpayers with securities sales. For 2014 tax reporting, many 1099-Bs may not report wash sales or other cost-basis adjustments leading taxpayers or their tax preparers to choose the short-cut option: to enter totals on Schedule D and omit the headache of preparing a Form 8949. But, we know very well that taxpayers are supposed to calculate wash sales differently from brokers, and there could be wash-sale adjustments that taxpayers should make on Form 8949, which probably changes the net capital gain or loss amount.

Section 1091 wash sale loss rules for taxpayers
Per IRS Publication 550: A wash sale occurs when you sell or trade stock or securities at a loss and within 30 days before or after the sale you:

  • Buy substantially identical stock or securities,
  • Acquire substantially identical stock or securities in a fully taxable trade,
  • Acquire a contract or option to buy substantially identical stock or securities, or
  • Acquire substantially identical stock for your individual retirement account (IRA) or Roth IRA.

An example of how wash-sale rules differ between brokers and taxpayers
IRS regulations require brokers to calculate and report wash sales per account based on identical positions (it’s reiterated in Form 1099-B instructions). Here is an example of broker rules: an account holder sells 1,000 shares of Apple stock for a loss and buys back 1,000 shares of Apple stock 30 days before or 30 days after in that same account. According to the 1099-B, that’s a wash-sale loss deferred (added) to the replacement position cost-basis. But, if the account holder buys back Apple options instead of Apple stock, according to broker rules it’s not a wash sale because an option is not “identical” to the same company’s stock – however the taxpayer must report it as a wash sale. Broker computer systems are programmed to calculate wash sales based on an identical symbol, and stock and options and options at different exercise dates have different symbols. In that same example, if the taxpayer bought back Apple stock in a separate account, including an IRA, the broker would not treat it as a wash sale, but according to Section 1091, the taxpayer must treat it as a wash sale.

Don’t assume that substantially identical positions are worse for wash-sale calculations; they could actually be better. Subsequent transactions with profit can absorb prior wash sales before year-end, which can fix a wash-sale problem. So a gain on an option can absorb a wash-sale loss on a stock. Note that Apple stock and Apple options are substantially identical, but Apple stock and Google stock are not substantially identical.

Ways to avoid Form 8949
Business traders qualifying for trader tax status are entitled to elect Section 475 mark-to-market (MTM) accounting elected on a timely basis. Section 475 business trades are not reported on Form 8949; they use Form 4797 Part II (ordinary gain or loss). Although Section 475 extricates traders from the compliance headaches of Form 8949 (and Section 475 trades are exempt from wash sale rules), it does not change their requirement for line-by-line reporting on Form 4797.

Form 8275-R disclosure
If you or your local tax preparer decide to cut corners and disregard Section 1091 taxpayer rules for calculating wash sales across all accounts based on substantially identical positions — choosing instead to rely on broker 1099-B reporting in spite of known broader wash-sale conditions (explained in Chapter 4) — then you need to “disclose items or positions that are contrary to Treasury regulations” on Form 8275-R included with your tax return filing. We asked a leading malpractice-insurance carrier for tax preparers about this issue and they said, “there is coverage for regulatory inquiries but not if the firm is investigated for preparer penalties.” Whether you knowingly or ignorantly cut corners relying on 1099-Bs for active securities traders, it’s a circular 230 infraction and ignorance is not an excuse. Use our guides and suggestions to do it right.

Software for wash sales
When you consider a securities trade accounting software and Web-based solution, ask the vendor if they calculate wash sales based on Section 1091 and if not, you may want to skip that solution.

TurboTax ads say they make taxes simple and they imply you can just import your 1099-B. You’ll spend a lot of time finding their small fine print about having to make Section 1091 adjustments on your own.

Don’t tackle this minefield on your own, get professional help
Every case is different and our CPAs will look for ways to work with what you provide us, and in some cases, we can make manual adjustments. For example, if you don’t have open wash sales at year-end, we may be able to find ways to generate proper tax forms using 1099Bs, broker tax reports, and software solutions that you provided to us. Green NFH also offers a securities trade accounting service using proper software to be fully compliant with Section 1091.

We used several excerpts from Green’s 2015 Trader Tax Guide for this blog. 


Tax treatment for forex and deposit losses after SNB’s surprise policy change

January 17, 2015 | By: Robert A. Green, CPA

Webinar Feb. 10, 2015 at 4:15 pm EST - Learn More

If you are one of many who got caught on the wrong side of the forex trade when the Swiss National Bank (SNB) surprised the markets with a huge policy change this week, you probably incurred significant losses. Here’s a quick primer on how to handle these losses on your tax returns.

First, it’s important to segregate your losses into two camps: the forex trading loss (Section 988 or capital loss) incurred on your open positions that were liquidated or closed by you or your broker, versus losing a deposit in an insolvent financial institution (Section 165). The latter also happened to traders who made money on this market event.

Forex tax treatment
By default, forex trading losses are Section 988 ordinary losses, unless you filed an internal contemporaneous capital gains election at any time before this new trading loss was incurred. In that case, it’s a capital loss subject to capital loss limitations of $3,000 per year against ordinary income. With a capital gains election in place, if you trade major currencies and don’t take or make delivery, you probably use Section 1256(g) lower 60/40 capital gains rates.

If you qualify for trader tax status (business treatment), Section 988 losses are business losses includible in net operating loss carry backs and forwards. But without trader tax status, you’ll need other income to absorb the forex ordinary loss, because the negative income part is otherwise wasted. If you’re using Section 1256(g), you can file a net Section 1256 loss carry back election for 2015 to carry the loss back three years to offset Section 1256 gains in those years. (Read more about forex tax treatment in our Trader Tax Center).

Deposit loss tax treatment
Hopefully, other banks and brokers will rescue teetering forex brokers and not too many forex traders will lose their deposits in insolvent financial institutions. That would be unfortunate since there is no FDIC or SIPIC money-protection on forex accounts. If U.S. and foreign forex brokers fail, hopefully the firms have private insurance that pays out the deposit holders in full for their deposit losses. If there is less than full recovery of deposit losses through insurance or otherwise, sustained losses are subject to Section 165 tax treatment.

We addressed similar issues when we covered the MF Global insolvency and recovery efforts over the past few years.

Excerpt from our Trader Tax Center
Many investors, traders and hedge funds got sideswiped by the MF Global and PFG bankruptcies over the past few years. Unfortunately, futures and forex account holders are not afforded government protection like bank account holders with FDIC protection and securities account holders with SIPIC protection. Tax treatment is far better when the IRS declares the loss a “theft loss”and allows application of IRS Revenue Procedure 2009-20, originally enacted to provide tax relief for investors in the Bernie Madoff Ponzi scheme. Theft losses receive ordinary loss treatment plus acceleration of losses on tax returns. Otherwise, Section 165 applies to deposit losses in insolvent financial institutions like MF Global. Investors are stuck choosing between capital loss treatment, which may trigger capital loss limitations, or itemized deduction treatment with various restrictions and haircuts. Business traders with trader tax status benefit from business ordinary loss treatment. Taxpayers with Section 165 losses must wait for the loss to be “sustained”so trustees have ample time for fund recovery. MF Global futures account holders recovered their losses in full, although forex account holders may have some sustained losses. (Read our blogs, PFG investors can deduct theft losses on 2012 tax returns with Rev. Proc. 2009-20 safe harbor relief, and MF Global & PFG Best deposit losses have nuanced tax treatment.)

I imagine bankruptcy trustees for these failing forex brokers will seek to recover funds from customers who incurred forex trading losses in excess of their deposits, unless the account agreements say otherwise. I also envision there will be arguments over who bears responsibility for excess losses, the broker or customer in cases where brokers liquidated positions and sometimes too late.

Disregard of CFTC rules
Many American forex traders disregarded CFTC rules (for retail off-exchange forex) by trading with non-registered offshore brokers offering leverage far above CFTC limits of 50:1 on major currencies and 20:1 on minor currencies. Several offshore brokers and a few U.S.-based forex brokers are facing financial strain or insolvency as a result of offering excess leverage to their customers during the SNB shockwave. When markets are extremely volatile the broker and customer may not be able to exit a trade before incurring a significant loss well in excess of the customer’s deposit amount. Let’s see how the money protection issue works out offshore.


Tax treatment for precious metals

January 7, 2015 | By: Robert A. Green, CPA

The collectibles tax rate on precious metals is high, learn how to improve after-tax returns.

There are many different ways to invest in precious metals and tax treatment varies.

Physical precious metals are “collectibles” which are a special class of capital assets. If collectibles are held over one year (long-term), sales are taxed at the “collectibles” tax rate — the taxpayer’s ordinary rate capped at 28%.

It’s different for regular capital assets like securities: individuals in the 10% and 15% ordinary income tax brackets pay 0% on long-term capital gains (LTCG); individuals in the 25%, 33% and 35% tax brackets pay 15% on LTCG; and individuals in the top 39.6% bracket pay 20% on LTCG.

This translates to materially higher tax rates on collectibles for all taxpayers in all tax brackets vs. regular LTCG tax rates. For this reason, many CPAs recommend clients invest in physical precious metals inside their IRAs. Congress and the IRS loosened the rules allowing IRAs to invest in precious metals.

If collectibles are held one year or less, the short-term capital gains ordinary tax rate applies no different from the regular STCG tax rate. Realized gains and losses in collectibles are reported on Form 8949 and Schedule D along with other capital gains and losses, which means the capital loss limitation of $3,000 against ordinary income applies on individual tax returns. There are special ordering rules for collectibles vs. other capital asset classes.

If you prefer the regular LTCG rate in your taxable accounts, you can get exposure to precious metals by investing in securities tied to the precious metals industry. These securities are no different from other securities with STCG up to 39.6% and LTCG rates up to 20%.

Traders appreciate precious metal futures since they are Section 1256 contracts with lower 60/40 tax rates and mark-to-market (MTM) accounting on a daily basis. Sixty percent is LTCG and 40% is STCG for a top blended rate of 28%, which is 12% less than the top STCG rate. MTM means you report both realized and unrealized gains and losses. The $3,000 capital loss limitation still applies. Alternatively, you may file a Section 1256 loss carryback election on top of Form 6781 when filing your tax return.

More about collectibles
When you invest in physical precious metals including bullion (coins and bars) or physical-backed precious metals ETFs — structured as grantor trusts which means you effectively own the bullion — the “collectibles” tax rate and rules apply.

Per Thomson Reuters Checkpoint tax research service:

  • “Collectibles gain or loss is gain or loss from the sale or exchange of a collectible which is a capital asset held for more than one year, but only to the extent such gain or loss is taken into account in computing gross income. (Code Sec. 1(h)(5)). Any work of art, rug or antique, (precious) metal or gem, stamp or coin, alcoholic beverage, or any other tangible personal property specified by IRS for this purpose is a collectible.” Precious metals jewelry meets the definition of collectibles.
  • “The term 28% rate gain means the sum of collectibles gain and losses and section 1202 gain (certain qualified small business stock), less the sum of collectibles loss, the net short-term capital loss for the tax year, and the long-term capital loss carryover to the tax year.RIA observation:As a result of the way the 28% rate gain is defined, a long-term capital loss carryover from an earlier tax year will always be used first to offset it.”

Examples: If X sells a collectible after one year and is in a low ordinary income tax bracket of 15%, then the collectibles tax rate is 15%. Conversely, if Y is in the ordinary tax bracket of 33%, the collectibles ordinary rate is capped at 28%. It’s not a blanket 28% rate for all taxpayers.

Nonphysical precious metal investments
If you want to avoid the higher collectibles tax rate and benefit from lower LTCG rates, consider investing in securities tied to precious metals, but not physically backed by precious metals.

For example, the popular gold ETF symbol GLD is a physical-backed precious metal ETF structured as a grantor trust and it’s deemed a collectible. Conversely, the gold mining ETF symbol GDX is a registered investment company (RIC) taxed as a security.

Here are some other examples of securities tied to precious metals: gold mining equities like symbols ABX and GG, gold mining ETFs (RICs) like GDXJ, gold mutual funds (RICs) like symbols SGGDX and TGLDX and gold mining exchange-traded notes (ETNs — debt securities) like symbols UBG and TBAR. Securities are not a pure-play investment in precious metals.

U.S. closed end funds (CEF) are also trusts treated as collectibles. But non-U.S. closed end funds like symbols CEF and GTU are offshore corporations subject to Passive Foreign Investment Company (PFIC) rules. For PFICs, consider a “qualified electing fund election” under Section 1295 filed on Form 8621 to enjoy LTCG tax rates. But unless you are making a significant investment, it may not be worth the extra tax red tape and oversight.

Section 1256 lower 60/40 capital gains tax rates
Traders always like Section 1256 because they get lower 60/40 tax rates even on fast trades; they don’t have to wait one year for lower LTCG rates. Gold futures contracts on U.S. futures and commodities exchanges qualify for Section 1256 tax treatment as regulated futures contracts (RFCs).

In their Journal of Accountancy article “Tax-Efficient Investing in Gold” dated Jan. 1, 2015, Steven H. Smith, Ph.D. and Ron Singleton, CPA, Ph.D. write that its also popular to invest in gold futures ETFs like symbols DGL and UGL, and gold futures ETNs. Our content on ETFs points out that sales of commodities/futures ETFs — structured as publically traded partnerships — are taxed like securities. Investors often receive a Schedule K-1 passing through Section 1256 contract income which requires an adjustment to cost basis as part of a sale transaction.

Breaking news from the IRS on IRAs and precious metals
Per Thomson Reuters tax service on Jan. 7, 2015, “IRAs can invest in trusts holding gold: In a private ruling, the IRS held that IRAs and individually directed accounts maintained by qualified retirement plans can invest in trusts holding gold without being treated as a distribution under IRC Sec. 408(m) (1). According to the IRS, the rules that prohibit direct investments by IRAs in gold do not apply if the gold is held by an independent trustee. In this ruling, shares in the trust are marketed to the public, including IRAs and individually directed plans, and are traded on a stock exchange. However, if the shares are redeemed for gold, the IRS says the exchange will be treated as an acquisition of a collectible (i.e., treated as a taxable distribution to the owner) except to the extent IRC Sec. 408(m)(3) is satisfied. PLR 201446030.”

The trend is your friend
When IRAs were created in 1974, Congress prohibited IRA investments in collectibles. In 1986, Congress allowed U.S. gold and silver coin investments and in 1998 it expanded that to pure (99.5%) bullion. In 2007, the IRS issued a PLR 200732026 that did not consider physical-backed precious metal ETFs like the GLD a collectible as held by IRAs — a clever way around the prohibition.

Expenses
Owning significant gold bullion requires expenses for storage and insurance. Holding a few gold coins in a safe deposit box has negligible cost. Even with securities and futures tied to precious metals, expenses are factored into the investment structures. Try to have IRAs and retirement plans pay their own investment expenses.

Bottom line
The price of gold had huge appreciation in the decade ending in 2012 and it’s been a rocky road down in price since then with volatility. Don’t lose sight of tax losses and the dreaded capital loss limitation, which applies to collectibles, precious-metal-tied securities and futures. At least you’ll get the benefit of losses inside a traditional IRA or retirement plan since it reduces your taxable distributions in retirement.

Postscript Feb. 26, 2015 about the option on GLD ETF
Many tax professionals treat the option on GLD (gold ETF) as a Section 1256 contract principally because it’s a non-equity option trading on a CFTC qualified board of exchange. Options on commodity ETFs structured as publicly-traded partnerships (PTP) are Section 1256 contracts. The GLD is a publicly-traded grantor trust, not a PTP. We understand that on their 2014 Form 1099Bs, Fidelity is treating the option on GLD as a stock option (a security) perhaps because if a taxpayer sells physical gold short term it’s a short-term capital gain just like a security. This may relate to the GLD being a grantor trust with disregarded ownership of the underlying assets – as if the owner of the ETF owns the gold bullion directly. A well respected tax information site Twenty-First.com lists the option on GLD as Section 1256 and it states “If the ETF is not set up as a RIC, but as a trust (like GLD) or a limited partnership (like USO), then listed options on the ETF would be treated as a non-equity option under Section 1256.” Click here for our content on ETFs.


6 items for your year-end tax shopping list

December 9, 2014 | By: Robert A. Green, CPA

Don’t let valuable tax deductions go down the drain. Attend our Dec. 11 webinar (or watch the recording) to discuss this content.

By Robert A. Green

Getting through your holiday “to-do” list — sending cards, gift buying, wrapping presents and baking cookies — is important for enjoying the holidays. The list may be long, but if you want gifts from Uncle Sam-ta, here are 6 items to add to it. Just be sure to execute them before year-end.

1. Make portfolio and business transactions for significant tax advantages.
Consider year-end transactions like selling winning or losing investment portfolio or business positions, invoicing clients and purchasing business items. If you are in the top tax bracket, defer income and accelerate expenses to reduce Obama-era tax hikes on income and net investment taxes (the combined federal tax rate is 44%). If you’re in lower tax brackets, accelerate income and defer expenses to utilize potentially wasted itemized deductions and take advantage of lower marginal tax brackets. A Roth IRA conversion is great for soaking up lower tax rates.  Learn more in our year-end tax planning blog and webinar.

2. Don’t get caught paying taxes on phantom income.  (Ouch! That would hurt.)
If you take a loss on a security toward year-end and buy back a substantially identical position in any of your taxable and/or IRA accounts within 30 days before or after, it’s considered a wash sale loss deferral (and permanently lost with an IRA). Break the chain on wash sales by not buying the position back in 30 days and get credit for the full tax loss in 2014.  Business traders should consider a Section 475 MTM election in 2015 to convert year-end wash sale losses on trading positions into business ordinary losses on Jan. 1. Turn garbage into gold!

3. You’ve set up your entity, but unless you execute compensation and employer 401(k) plans before year-end, its employee-benefit plan tax deductions will go down the drain.
Watch our video about how to use Paychex. It takes up to two weeks to sign up and execute compensation and an employer 401(k) plan, so get going today. If you want to save thousands of dollars with retirement plan and health insurance tax deductions (employee-benefit plans) for 2014, you must act on time. Plan to pay the 401(k) elective deferral portion by year-end. You can wait to fund the 25% profit-sharing plan through the due date of your 2014 tax return (including extension).

4. Don’t miss the boat on 2015; set up your trading business and entity for Jan. 2.
If you’ve been waiting to set up your trading business entity, starting on Jan. 2, 2015 is more convenient and beneficial. It breaks the chain on wash sales with your individual taxable and IRA accounts at year-end, since the entity is a different taxpayer identification number. 2015 tax compliance is easier and lower in cost, since you’ll report the entire year’s trading business activity on the entity return and skip individual tax compliance for part of the year in connection with trading activities.

It’s a little tricky to time the entity formation to a Jan. 2 start date. We can form a single-member LLC disregarded entity in December so you can execute the legal paper work and open the bank and trading accounts before year-end. We’ll add your spouse and or file the S-Corp election effective Jan. 1, 2015. As a disregarded entity in 2014, the SMLLC doesn’t force a partnership or S-Corp tax filing for 2014, even for a simple inactive entity tax return. However, in some states like California, we should wait until Jan. 2 to form the LLC, since that state charges a $800 minimum tax on LLCs even for just a few days in 2014. Consider our entity formation service.

5. Don’t get slapped with an underestimated tax payment penalty.
Get caught up with your 2014 estimated income taxes. Many traders underpay estimated taxes during the year, viewing the underestimated tax penalty as a low-cost margin loan. Why prepay taxes when you aren’t sure how the year will wind up? The Q4 estimate is due Jan. 15, 2015, so you can see where you stand at year-end first. Consider paying the state before year-end for another 2014 tax deduction, unless you trigger AMT and don’t get that benefit (state taxes are an AMT preference item).

6. The clock is ticking on RMDs, charitable contributions, gifts and FSAs.
Do your required minimum distributions (RMDs) from retirement plans, including Inheritor IRAs, and charitable contributions and gifts before year-end.  If you have a flexible spending account (FSA) with an employer, you must “use it or lose it” before year-end.

Contact us ASAP: We are standing by to help our clients with these transactions.

Happy holidays from all of us at Green NFH, LLC.

Adam Manning contributed to this blog.

 


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