Flow-Through Entities and Taxes

B

bro59

With regard to flow-through entities and the treatment of disbursements to the trader or partner:

Have there been any recent cases or personal experiences of the IRS challenging the status of the individual's trader status? When the entity is considered to be conducting trading as a business, and making the mark-to-market election, it is conceivable that the trader would be disallowed this status should it be questioned.

With so many traders over the last few years trading under proprietary shops, I just thought perhaps someone has experience with this being an issue. Of course, the IRS may have simply decided it isn't worth addressing since the risk/reward from their perspective may not be worth the chase.
 
If you're trading actively, i.e. daily or so, and trading is your primary source of income/time spent vocationally, the IRS will be hard pressed to argue convincingly that you don't deserve treatment under trader status.
 
What Bro 59....is saying is the income derived from the free leverage that the prop shop provides is not treated as earned income.

But many other tax-saving instruments have these characteristics.....

Michael B.
 
Here are some concerns posted by Kaye Thomas from Fairmark Press:

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

Alternatively, I wondered if possibly since under these Prop arrangements the entity is considered to be the "trader" then possibly the members might not be for tax purposes. Can the K1 definitively be defined as income derived from trading in securities or is it just partnership income? This could be an issue with deductions since these K1's (at least at my firm) don't allow non-partnership expenses, ie. your own expenses, to be shown on the K1.

If my musings here seems muddled then I apologize. I'll blame it on the state of the Code.
 
General partnership rules allow a partner to deducts all of his expenses related to the partnership that were not included on the K-1 that were paid with his personal funds on schedule E of the individual tax return.

So you can deduct training fees, magazine, internet connection, and other trading expenses on schedule E and it will reduce taxable income. From my perspective the IRS does not care about prop traders, very little income and not many of them. They just want to keep the millionaires and others in high tax brackets from deducting investing expenses.

Also, most IRS agents are clueless about tax law and even basic rules. They will look at Travel and entertainment, earned income credit and match W-2s and 1099s.

Good luck



Quote from bro59:

Here are some concerns posted by Kaye Thomas from Fairmark Press:

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

Alternatively, I wondered if possibly since under these Prop arrangements the entity is considered to be the "trader" then possibly the members might not be for tax purposes. Can the K1 definitively be defined as income derived from trading in securities or is it just partnership income? This could be an issue with deductions since these K1's (at least at my firm) don't allow non-partnership expenses, ie. your own expenses, to be shown on the K1.

If my musings here seems muddled then I apologize. I'll blame it on the state of the Code.
More...
 
I did experience one issue with a client that went through a resent audit. This particular client was a very active trader (had over a 1000 trades that year alone) and his primary source of income was trading. This is all the client did all day long. He claimed trader status on his tax return and the IRS denied this status and disallowed all of his trader deductions as well as his Mark-to-Marketing accounting election. The auditor did not provide any support for his adjustment other than the fact that he was instructed from higher ups in the IRS to disallow all deductions from individuals that have claimed trader status. This occurred in an IRS office in Glendale California. I have not heard of this occurring in any other IRS office but it does concern me quite a bit. I may be handling the appeal of this audit and I will up date you as this progresses.
 
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