Deducting trading expenses?

H

heech

Hi all,

I've been trading "full-time", but not really for the last year. I have automated code executing 24/7, and trade about 1000 contracts a month. However, I also have a full time job in a different career.

I've been told by my CPA (who seems competent, but doesn't specialize in trading issues) that trying to treat my trading as a business would not be possible, because the IRS sees my non-trading full time job as proof the trading side of things isn't my "business". This wasn't a major issue before, but trading-related expenses are starting to add up. Considering server hosting, data feeds, software, and other costs... I'm probably looking at ~$10k-$15k in trading-related expenses this year.

Anyone have any input on this issue?
 
Write it off, and get a new CPA that specializes in trader's accounting. Do you think the IRS knows you are not sitting at your screen 6 hours a day?
 
Quote from heech:


.....
I've been told by my CPA (who seems competent, but doesn't specialize in trading issues) that trying to treat my trading as a business would not be possible, because the IRS sees my non-trading full time job as proof the trading side of things isn't my "business".
.....
More...

I suggest that you read a few publications from the IRS and a few articles on the Internet about taxes on trading.

Here's my take:

- Anybody who works full time (taking a salary, W-2) can own one or more businesses at the same time. There is no law that says "because you have a full-time job, you cannot possibly own any businesses". Some people operate a laundry mat, a hotdog stand, whatever while they have a 40-hour per week job. It's perfectly all right. Trading is just like any other business - as long as you treat your trading as a business and not a hobby. That you are not an "investor" who pretends to be a trader to write off your expenses.

- If you establish trading as your business, you can use Schedule C to deduct your business expenses, but use Schedule D to report your gain/loss from trading. Don't report your trading gain/loss as income in Schedule C. Or else IRS will require you to pay self-employment tax. You should be able to write off your trading expenses on Schedule C.


To be a trader, you need to pass 2 tests:

- Substantial activity test. With 1000 contracts traded a month, I don't think there should be any doubt on this.
- Trading activity test (the main thrust of your activity is trying to capture short-term swings in market prices rather than profit from dividends and share appreciation.)


Excerpts from some of the articles:

Are You a Trader?

The word trader has a special meaning in the tax law. It refers to someone who trades to catch short-term swings in market prices (not long-term appreciation or dividends and interest), and does so in a large enough volume, consistently over a long enough period of time. The biggest problem with trader status is the absence of a clear definition. There are no precise standards telling us when trades are considered short-term, or how large a volume you need, or how long a period you must continue the activity to be considered a trader. Sometimes it's easy to determine that someone is or is not a trader, but in many cases the answer isn't clear.

Tax Benefits

If you're a trader, you're likely to be able to claim more deductions than an investor. Some deductions that would be claimed as itemized deductions subject to various limits will be allowed as business deductions, without such limits. And there are some deductions traders can claim even though investors can't claim them at all.

In addition, traders are eligible to make the mark-to-market election. If you make this election, your trading losses won't be subject to the $3,000 capital loss limitation. This limitation can be very painful for a trader who has a bad year.
Filing as a Trader

If you're a trader who has not made the mark-to-market election, your trading expenses go on Schedule C, the form used to report business income and expenses. But your trading income is capital gain, and has to be reported on Schedule D. This looks very strange indeed to tax professionals who are not familiar with trader filing, but this is how it is done.
More...


http://www.fairmark.com/news/08091201-trader-holsinger.htm

http://www.fairmark.com/traders/intro.htm

- IRS Publication 550 now includes a short section on traders, with essentially the same information you'll find in the tax return instructions.



Read up on them and decide for yourself.
 
BTW: I don't think that to be a trader (running a trading business) that you need to be in front of a screen for 6+ hours a day anyway. Some can trade 2-3 hours a day and that's it. It's still a business.

And since you mentioned that it's automated trading, you don't need to sit in front of a screen at all. (Or may be attend to matters for only a few minutes a day). It's still a business.
 
Quote from Bolimomo:

BTW: I don't think that to be a trader (running a trading business) that you need to be in front of a screen for 6+ hours a day anyway. Some can trade 2-3 hours a day and that's it. It's still a business.

And since you mentioned that it's automated trading, you don't need to sit in front of a screen at all. (Or may be attend to matters for only a few minutes a day). It's still a business.
More...
I think the Fairmark link above presents exactly how many CPAs, including my own, see the trader election issue:

"Many individual investors . . . want to take the position that they are full-time traders for tax purposes so that they can deduct their expenses and elect section 475(f). . . . In court, these people have a snowball's chance in hell of prevailing. Numerous cases hold that individual day traders do not have a trade or business of trading securities."

I mean, that's a pretty categorical statement. But for those who follow the link above, the argument is some individual traders *can* meet the requirement. On any reasonable standard (beyond the "snowball in hell" one), I think I should meet the requirement.
 
Good response. You also have to demonstrate that your activity is continuous. If you trade for a month and then take time off you will have a hard time satisfying this requirement. If you try and deduct your expenses expect the IRS to challenge it.

Find another person you can trust (spouse, mom, dad, or other) and form a Limited Partnership. I'm not a CPA so I don't know for sure but I think this will get you over the hump. You will not lose the 60/40 tax benefit with this entity.

Quote from Bolimomo:

I suggest that you read a few publications from the IRS and a few articles on the Internet about taxes on trading.

Here's my take:

- Anybody who works full time (taking a salary, W-2) can own one or more businesses at the same time. There is no law that says "because you have a full-time job, you cannot possibly own any businesses". Some people operate a laundry mat, a hotdog stand, whatever while they have a 40-hour per week job. It's perfectly all right. Trading is just like any other business - as long as you treat your trading as a business and not a hobby. That you are not an "investor" who pretends to be a trader to write off your expenses.

- If you establish trading as your business, you can use Schedule C to deduct your business expenses, but use Schedule D to report your gain/loss from trading. Don't report your trading gain/loss as income in Schedule C. Or else IRS will require you to pay self-employment tax. You should be able to write off your trading expenses on Schedule C.


To be a trader, you need to pass 2 tests:

- Substantial activity test. With 1000 contracts traded a month, I don't think there should be any doubt on this.
- Trading activity test (the main thrust of your activity is trying to capture short-term swings in market prices rather than profit from dividends and share appreciation.)


Excerpts from some of the articles:




http://www.fairmark.com/news/08091201-trader-holsinger.htm

http://www.fairmark.com/traders/intro.htm

- IRS Publication 550 now includes a short section on traders, with essentially the same information you'll find in the tax return instructions.



Read up on them and decide for yourself.
More...
 
Quote from StLouisTrader:

How much money do u make from your trading "business"? The ability to rack up expenses doesn't mean much in the absence of significant income.
More...

I don't think making a profit is a requirement for running a business and deducting expenses. Many startup companies lose money in the first few years. Trading is the same. And in trading, sometimes one can have a losing year dispite of many years of profitability.

The expense deduction can offset some of the ordinary income from W2 and other income sources (such as interest/dividends).

Of course if you have losses year after year after year on the same business, IRS will eventually ask you why you still stay "in business".
 
Quote from Bolimomo:

Of course if you have losses year after year after year on the same business, IRS will eventually ask you why you still stay "in business".
More...
As would my wife!
 
You must log in or register to reply here.
Back
Top