it's moot. You had to make the election by 4/15/2002 for 2002.
First-year, newbie casual trader tax question
- Thread starter toad57
- Start date
If and when you start making a profit
you will get better tax treatment trading futures. It is treated like regular income not capital gains.
The Market to Market designation is good if you need to have a business to pay SSI for retirement and disability or get health or disability insurance from a private company.
Hope this helps?
you will get better tax treatment trading futures. It is treated like regular income not capital gains.
The Market to Market designation is good if you need to have a business to pay SSI for retirement and disability or get health or disability insurance from a private company.
Hope this helps?
Quote from bobcathy1:
If and when you start making a profit
you will get better tax treatment trading futures. It is treated like regular income not capital gains.
The Market to Market designation is good if you need to have a business to pay SSI for retirement and disability or get health or disability insurance from a private company.
Hope this helps?
Are you sure futures profits are treated as ordinary income. It flows through Sch "D" after the 60/40 split. MTM profits are definitely treated as ordinary income.
Later,
Cracked
Identify Yourself: Are You a âTraderâ in the Eyes of the IRS?
by: Ted Tesser
There are tax advantages to be classified as a âtrader,â but certainly not everyone qualifies in the eyes of the IRS. This article points out some of the things you may want to explore more closely as you seek to determine in which classification you rightfully belong.
As the tax deadline date approaches, we all seek valid ways of reducing our tax burden. One avenue open for some individual investors is to claim âtrader status.â For tax purposes, the distinction of being a âtraderâ is now more important than ever, and there are several reasons for this.
First, trader status allows you to write off all trading losses (beyond $3,000) on your tax return, whereas a non-trader is not able to do so (with the election of Section 475). Second, a Market-Maker/Broker Dealer would be subject to self-employment tax, whereas a trader would not. Third, a trader, as opposed to an investor, can deduct dollar-for-dollar trading expenses, above the line, rather than as itemized deductions subject to phase-outs and limitations. In addition, a trader, working within entities (i.e., Family Limited Partnerships and Corporations) is able to set up retirement plans and employee benefit programs (such as VEBAs and 419 Trusts where unlimited amounts of money can be sheltered), whereas this option is not open to an investor. While some benefits were recently eliminated, the bulk of this important advantage has remained intact.
While there are many other benefits to being classified as a trader, they are too numerous to discuss in a single article of this length (The New Traderâs Tax Solution delves into every aspect of the trader advantages available since the new tax code took effect). However, for the scope of this article, we have confined the topic to the most important reasons some readers should seriously consider this option when preparing their tax return. Whether youâre an equities trader, an option player, someone who dabbles in currency trading or just getting started in the new single stock futures revolution ââ these provisions in the tax code can greatly reduce your tax burden. Why let Uncle Sam take a bigger bite out of your hard-earned trading profits or losses ââ when you can easily avail yourself of the legal âloopholesâ afforded us in the new tax law?
Who Are the Market Participants? The tax code has always given us three designations of market participants, two of which have been clearly defined â the broker-dealer/market maker and the investor â and one that has not. The last subjective distinction â âTraderâ â holds many advantages that the first two do not. Briefly, letâs go into each, so you can see the benefits one can obtain by claiming âtraderâ status â and then weâll dig more in depth on how you can determine whether you actually qualify for the âtraderâ classification.
The Broker-Dealer/Market Maker Reg. Section 1.471-5 of the tax code defines a dealer in securities as âsomeone who engages in the purchase of securities for resale to customers, with the intent of making a profit.â The broker dealer/market-maker is a merchant with an established place of business who regularly engages in this practice.
He or she, therefore, treats securities or commodities as inventory that is held for sale to his or her customers and is treated as ordinary, not capital, assets. This results in the generation of ordinary income or loss, not capital income or loss.
Dealers can deduct, dollar for dollar, any expense they incur in transacting business. Also, the broker-dealer/market maker is not limited to the $3,000 per year capital loss that restricts other taxpayers (including most traders). This is a major distinction. In addition, any income generated from these assets is considered ordinary with regard to self-employment tax, retirement plan contributions, self-employed health deduction and, as of 1993, market-to-market considerations (Section 475). Finally, individual broker-dealer/market makers must pay self-employment tax on all their income.
And Then Thereâs the Investor An investor, on the other hand, is clearly defined in the tax code under Section 263 (a) as a person who buys or sells securities for his or her own account, as opposed to a dealer who buys and sells for resale to customers. All expenses of the investing activity are considered to be investment expenses, with treatment as miscellaneous itemized deductions on Schedule A of an investorâs tax return and subject to signifcant limitations and phase-outs.
All income is considered to be capital gain income and not subject to self employment tax, not eligible for retirement plan contributions, or the self-employed health deduction, and, hence, reported on Schedule D.
Furthermore, an investor is always limited to a $3,000 per year net capital loss deduction, which can be carried forward for his or her lifetime (or even carried back for three years, in the case of Section 1256 transactions-commodities, futures and certain types of index or futures options).
The Third Category - Traders Traders constitute a hybrid category. There is no election on the tax return you can make to indicate that you are a trader. But the cases decided over the past 65 years in the Supreme Court and various district tax courts have recognized this hybrid category and have established that traders are investors who engage in the purchase and sale of securities for their own accounts. However, they do so at such a high level of activity that it becomes a business to them.
There are no objective requirements in the tax code to qualify a person as a trader and until the Taxpayer Relief Act of 1997, the distinction was barely acknowledged in the tax code. It was agreed that a trader was someone who trades in stock, securities, futures contracts or options on a relatively short-term and active basis, but this classification was purely subjective.
Now, in paragraph 341 of the 1997 tax act, Congress has distinguished a trader from a broker-dealer/market maker as follows:
âTraders are taxpayers who are in the business of actively buying, selling exchanging securities or commodities in the market. On the other hand, dealers deal directly with customers when they regularly buy or sell securities in the course of their businessâ¦â
Further, on December 17, 1997, the Joint Committee on Taxation issued its report (a.k.a. the Blue Book), to explain the new tax law. Page 180 of this report, Title X, Section A (financial products), sub-section 1001 (b), states:
âTraders in securities generally are taxpayers who engage in a trade or business involving active sales or exchanges of securities on the market rather than to customersâ¦â This section was codified into law in 1998.â
What Makes a Trader a Trader? It is obvious these definitions are, at best, vague. What Congress has done is allude to, but not strictly define, the status of âtrader.â It is the court cases throughout history that have really defined what determines trader status and what distinguishes a trader from an investor. From my 30 plus years of experience in this field and through filing thousands of trader tax returns, and through subjective analysis, I can pretty much âfeel outâ what the IRS view will be.
These criteria are the same whether the trader is trading securities, options, commodities, a complex basket of instruments or, in fact, any trading vehicle.
I glean my information through the use of a Trader Evaluation Questionnaire that I have all clients or prospective clients fill out. We evaluate this proprietary questionnaire at no cost to anyone who submits it to us at our web site (carl@taxtrader.com) to assist in making a determination. There is also an abbreviated online version of the questionnaire if one wishes to fill it out online (also free of charge).
Take a look at the actual questionnaire in the sidebar of this article to give yourself some idea of the types of things that are important in making a determination, but next letâs discuss the reasons for some of those questions.
by: Ted Tesser
There are tax advantages to be classified as a âtrader,â but certainly not everyone qualifies in the eyes of the IRS. This article points out some of the things you may want to explore more closely as you seek to determine in which classification you rightfully belong.
As the tax deadline date approaches, we all seek valid ways of reducing our tax burden. One avenue open for some individual investors is to claim âtrader status.â For tax purposes, the distinction of being a âtraderâ is now more important than ever, and there are several reasons for this.
First, trader status allows you to write off all trading losses (beyond $3,000) on your tax return, whereas a non-trader is not able to do so (with the election of Section 475). Second, a Market-Maker/Broker Dealer would be subject to self-employment tax, whereas a trader would not. Third, a trader, as opposed to an investor, can deduct dollar-for-dollar trading expenses, above the line, rather than as itemized deductions subject to phase-outs and limitations. In addition, a trader, working within entities (i.e., Family Limited Partnerships and Corporations) is able to set up retirement plans and employee benefit programs (such as VEBAs and 419 Trusts where unlimited amounts of money can be sheltered), whereas this option is not open to an investor. While some benefits were recently eliminated, the bulk of this important advantage has remained intact.
While there are many other benefits to being classified as a trader, they are too numerous to discuss in a single article of this length (The New Traderâs Tax Solution delves into every aspect of the trader advantages available since the new tax code took effect). However, for the scope of this article, we have confined the topic to the most important reasons some readers should seriously consider this option when preparing their tax return. Whether youâre an equities trader, an option player, someone who dabbles in currency trading or just getting started in the new single stock futures revolution ââ these provisions in the tax code can greatly reduce your tax burden. Why let Uncle Sam take a bigger bite out of your hard-earned trading profits or losses ââ when you can easily avail yourself of the legal âloopholesâ afforded us in the new tax law?
Who Are the Market Participants? The tax code has always given us three designations of market participants, two of which have been clearly defined â the broker-dealer/market maker and the investor â and one that has not. The last subjective distinction â âTraderâ â holds many advantages that the first two do not. Briefly, letâs go into each, so you can see the benefits one can obtain by claiming âtraderâ status â and then weâll dig more in depth on how you can determine whether you actually qualify for the âtraderâ classification.
The Broker-Dealer/Market Maker Reg. Section 1.471-5 of the tax code defines a dealer in securities as âsomeone who engages in the purchase of securities for resale to customers, with the intent of making a profit.â The broker dealer/market-maker is a merchant with an established place of business who regularly engages in this practice.
He or she, therefore, treats securities or commodities as inventory that is held for sale to his or her customers and is treated as ordinary, not capital, assets. This results in the generation of ordinary income or loss, not capital income or loss.
Dealers can deduct, dollar for dollar, any expense they incur in transacting business. Also, the broker-dealer/market maker is not limited to the $3,000 per year capital loss that restricts other taxpayers (including most traders). This is a major distinction. In addition, any income generated from these assets is considered ordinary with regard to self-employment tax, retirement plan contributions, self-employed health deduction and, as of 1993, market-to-market considerations (Section 475). Finally, individual broker-dealer/market makers must pay self-employment tax on all their income.
And Then Thereâs the Investor An investor, on the other hand, is clearly defined in the tax code under Section 263 (a) as a person who buys or sells securities for his or her own account, as opposed to a dealer who buys and sells for resale to customers. All expenses of the investing activity are considered to be investment expenses, with treatment as miscellaneous itemized deductions on Schedule A of an investorâs tax return and subject to signifcant limitations and phase-outs.
All income is considered to be capital gain income and not subject to self employment tax, not eligible for retirement plan contributions, or the self-employed health deduction, and, hence, reported on Schedule D.
Furthermore, an investor is always limited to a $3,000 per year net capital loss deduction, which can be carried forward for his or her lifetime (or even carried back for three years, in the case of Section 1256 transactions-commodities, futures and certain types of index or futures options).
The Third Category - Traders Traders constitute a hybrid category. There is no election on the tax return you can make to indicate that you are a trader. But the cases decided over the past 65 years in the Supreme Court and various district tax courts have recognized this hybrid category and have established that traders are investors who engage in the purchase and sale of securities for their own accounts. However, they do so at such a high level of activity that it becomes a business to them.
There are no objective requirements in the tax code to qualify a person as a trader and until the Taxpayer Relief Act of 1997, the distinction was barely acknowledged in the tax code. It was agreed that a trader was someone who trades in stock, securities, futures contracts or options on a relatively short-term and active basis, but this classification was purely subjective.
Now, in paragraph 341 of the 1997 tax act, Congress has distinguished a trader from a broker-dealer/market maker as follows:
âTraders are taxpayers who are in the business of actively buying, selling exchanging securities or commodities in the market. On the other hand, dealers deal directly with customers when they regularly buy or sell securities in the course of their businessâ¦â
Further, on December 17, 1997, the Joint Committee on Taxation issued its report (a.k.a. the Blue Book), to explain the new tax law. Page 180 of this report, Title X, Section A (financial products), sub-section 1001 (b), states:
âTraders in securities generally are taxpayers who engage in a trade or business involving active sales or exchanges of securities on the market rather than to customersâ¦â This section was codified into law in 1998.â
What Makes a Trader a Trader? It is obvious these definitions are, at best, vague. What Congress has done is allude to, but not strictly define, the status of âtrader.â It is the court cases throughout history that have really defined what determines trader status and what distinguishes a trader from an investor. From my 30 plus years of experience in this field and through filing thousands of trader tax returns, and through subjective analysis, I can pretty much âfeel outâ what the IRS view will be.
These criteria are the same whether the trader is trading securities, options, commodities, a complex basket of instruments or, in fact, any trading vehicle.
I glean my information through the use of a Trader Evaluation Questionnaire that I have all clients or prospective clients fill out. We evaluate this proprietary questionnaire at no cost to anyone who submits it to us at our web site (carl@taxtrader.com) to assist in making a determination. There is also an abbreviated online version of the questionnaire if one wishes to fill it out online (also free of charge).
Take a look at the actual questionnaire in the sidebar of this article to give yourself some idea of the types of things that are important in making a determination, but next letâs discuss the reasons for some of those questions.
Reasons for the Key Questions in Making Trader Determination
1) What do you trade or invest? It has been determined in the courts that preference is given to trader status for those who trade options and/or commodities. Two cases come to mind: Marlowe King vs. the Commissioner and Reinarch vs. the Commissioner, where in both cases it was explicitly stated that options and commodities are not generally considered to be investment vehicles.
2) How many transactions do you average per month? It is important to determine how substantial your trading activity is. How much activity is enough? That I canât say for sure. That depends on other factors as well. Do you trade full time? Do you have another job? You had better have more transactions if you only trade part time. If you trade full time, you may be able to get away with less trades. I recently got through a successful audit on an amended return of a new client and got this taxpayer back close to $250,000 with only 94 trades. But he traded full time.
I can tell you for certain how many trades are not enough. In a recent court decision, one taxpayer was denied trader status although, in fact, all he did was trade commodities. The problem was, however, that he only had 27 trades â over three years!
3) What is your average holding period? The courts want to see that you are trying to capture short-term swings in market movement, not holding the trading vehicle to appreciate to its true worth. Ropfogel vs. the Commissioner was a case that first stated these criteria, and there have been others since.
4) Do you trade full time? In my audit experience with the IRS, I have found it much easier to let other factors slip if the person is doing their trading full time. Nowhere does it say that you must do it full time and, in fact, many traders do it part time. As I have stated, if you do it part time, the IRS will be more stringent on what is required. Use a journal to document that you are putting substantial time into your trading activity.
5) If you have another job, is it full time or part time? A part time job will leave you with more time to trade in the eyes of the IRS. A job in the securities industry substantiates your case a bit more. A related background makes it easier to prove trader status in an audit. But again, nothing is absolute or required. Remember, this is just another component, not the key factor.
6) How frequently do you trade (Intra-day, daily, weekly, monthly)? I like to see people who trade either intra-day or daily. Daily is okay, but weekly and monthly is pushing it, unless you have a large number of trades. If you trade monthly, you better have a large number of other supporting factors.
7) When you are not making trades, how frequently do you watch the market to evaluate when you should trade (intra-day, daily, weekly, or monthly)? In other words, how closely are you tending to your business?
8) Do you keep a journal to indicate time spent trading/watching the market? Logs and journals are two of the most important tools a trader can use to substantiate trading activity, especially if the number of trades of trades is low. There is an appendix in The New Traderâs Tax Solution which shows how to set this up and offers a proven method for turning your logs into court room evidence.
9) How many hours do you spend on your analysis of your trading activity? In other words, how much time are you putting into your trading business?
10) Do you have the intent of short or long-term profit from your position? The IRS wants to see the intent of short-term profit, and intent can usually be demonstrated by what you do.
11) Do you have an office to trade from? If you say you have a business, you better have a place to do business from! In a prior case in tax court, trader status was thrown out because the trader did not have an office. Here is one instance where a home office will strengthen your tax return, instead of flag it for audit, like you usually hear!
12) Do you intend to receive dividends from you positions? The IRS has always held that if someone holds a position for the sake of getting dividends, then he is by nature an investor. And, once again, intent is generally demonstrated by results. So if you have many dividends on your tax return you better classify yourself as both a trader and an investor (you can be both), and allocate expenses between the two categories.
13) Do you trade by technical analysis or fundamental analysis? It has been stated in more than one court case that technical analysis lends itself to trader status, whereas fundamental analysis lends itself to investing.
14) Do you file a Schedule C listing yourself as a business (trader)? In a famous court case in the 1980s a lawyer, who was also a trader, was denied trader status because he failed to list himself as a business (Schedule C). In Purvis vs. the Commissioner, it was determined that if the taxpayer really ran a trading business, then he would have shown that on his tax return by filing a Schedule C.
15) Are you living off your trading profits? If you are doing this, making money and supporting yourself trading, it will be almost impossible for the IRS to deny you trader status. It will be very difficult for the IRS to disprove that you have a valid business.
And, Finally⦠Obviously, claiming trader status is not appropriate for everyone, but will be for more people than those who realize it. This article only skims the surface of the tremendous benefits it provides â whether youâre trading equities, options or futures. But for todayâs active traders, the âtrader statusâ option should be seriously considered.
Even if you havenât qualified in the past ââ you should think about structuring your accounts accordingly for the new tax year as you embark on your 2003 trading. Or better yet, have a professional make that determination for you. After all, why let Uncle Sam take more of your hard earned money â or trading profits - than is absolutely necessary, if you truly qualify for trader status?
1) What do you trade or invest? It has been determined in the courts that preference is given to trader status for those who trade options and/or commodities. Two cases come to mind: Marlowe King vs. the Commissioner and Reinarch vs. the Commissioner, where in both cases it was explicitly stated that options and commodities are not generally considered to be investment vehicles.
2) How many transactions do you average per month? It is important to determine how substantial your trading activity is. How much activity is enough? That I canât say for sure. That depends on other factors as well. Do you trade full time? Do you have another job? You had better have more transactions if you only trade part time. If you trade full time, you may be able to get away with less trades. I recently got through a successful audit on an amended return of a new client and got this taxpayer back close to $250,000 with only 94 trades. But he traded full time.
I can tell you for certain how many trades are not enough. In a recent court decision, one taxpayer was denied trader status although, in fact, all he did was trade commodities. The problem was, however, that he only had 27 trades â over three years!
3) What is your average holding period? The courts want to see that you are trying to capture short-term swings in market movement, not holding the trading vehicle to appreciate to its true worth. Ropfogel vs. the Commissioner was a case that first stated these criteria, and there have been others since.
4) Do you trade full time? In my audit experience with the IRS, I have found it much easier to let other factors slip if the person is doing their trading full time. Nowhere does it say that you must do it full time and, in fact, many traders do it part time. As I have stated, if you do it part time, the IRS will be more stringent on what is required. Use a journal to document that you are putting substantial time into your trading activity.
5) If you have another job, is it full time or part time? A part time job will leave you with more time to trade in the eyes of the IRS. A job in the securities industry substantiates your case a bit more. A related background makes it easier to prove trader status in an audit. But again, nothing is absolute or required. Remember, this is just another component, not the key factor.
6) How frequently do you trade (Intra-day, daily, weekly, monthly)? I like to see people who trade either intra-day or daily. Daily is okay, but weekly and monthly is pushing it, unless you have a large number of trades. If you trade monthly, you better have a large number of other supporting factors.
7) When you are not making trades, how frequently do you watch the market to evaluate when you should trade (intra-day, daily, weekly, or monthly)? In other words, how closely are you tending to your business?
8) Do you keep a journal to indicate time spent trading/watching the market? Logs and journals are two of the most important tools a trader can use to substantiate trading activity, especially if the number of trades of trades is low. There is an appendix in The New Traderâs Tax Solution which shows how to set this up and offers a proven method for turning your logs into court room evidence.
9) How many hours do you spend on your analysis of your trading activity? In other words, how much time are you putting into your trading business?
10) Do you have the intent of short or long-term profit from your position? The IRS wants to see the intent of short-term profit, and intent can usually be demonstrated by what you do.
11) Do you have an office to trade from? If you say you have a business, you better have a place to do business from! In a prior case in tax court, trader status was thrown out because the trader did not have an office. Here is one instance where a home office will strengthen your tax return, instead of flag it for audit, like you usually hear!
12) Do you intend to receive dividends from you positions? The IRS has always held that if someone holds a position for the sake of getting dividends, then he is by nature an investor. And, once again, intent is generally demonstrated by results. So if you have many dividends on your tax return you better classify yourself as both a trader and an investor (you can be both), and allocate expenses between the two categories.
13) Do you trade by technical analysis or fundamental analysis? It has been stated in more than one court case that technical analysis lends itself to trader status, whereas fundamental analysis lends itself to investing.
14) Do you file a Schedule C listing yourself as a business (trader)? In a famous court case in the 1980s a lawyer, who was also a trader, was denied trader status because he failed to list himself as a business (Schedule C). In Purvis vs. the Commissioner, it was determined that if the taxpayer really ran a trading business, then he would have shown that on his tax return by filing a Schedule C.
15) Are you living off your trading profits? If you are doing this, making money and supporting yourself trading, it will be almost impossible for the IRS to deny you trader status. It will be very difficult for the IRS to disprove that you have a valid business.
And, Finally⦠Obviously, claiming trader status is not appropriate for everyone, but will be for more people than those who realize it. This article only skims the surface of the tremendous benefits it provides â whether youâre trading equities, options or futures. But for todayâs active traders, the âtrader statusâ option should be seriously considered.
Even if you havenât qualified in the past ââ you should think about structuring your accounts accordingly for the new tax year as you embark on your 2003 trading. Or better yet, have a professional make that determination for you. After all, why let Uncle Sam take more of your hard earned money â or trading profits - than is absolutely necessary, if you truly qualify for trader status?