Thank you for your comments and explanations. Very helpful advice and clarify my situations for me.
Option trader tax status
- Thread starter iTradeOptions
- Start date
As someone who more and more feels that I would clearly be considered a "trader" in the IRS view based on all the things they say to consider (my tax return is like an inch thick!), I'd like to first share a website article I read this week:
http://www.marketwatch.com/story/tax-strategies-for-day-traders-2015-02-25?link=MW_latest_news
The article makes it seem rather simple. According to the article, the trader simply adds a Schedule C to the return with a letter of explanation, and on the Schedule C will go the business expenses and margin interest. The advantage is in the treatment of the expenses on the Schedule C, and the treatment bypasses the usual limit of 2% of AGI while reducing AGI.
The article also states the added benefits of becoming a "mark-to-market" trader, which eliminates wash sale rules, as well as the $3000 limit for capital gains losses. It appears Part II of Form 4797 is the form to utilize for gains and losses for "mark-to-market" trading.
So if the trader has little business expense, no margin interest, no wash sales, and net profits on the year, there is really no benefit to TTS. But if any of those 4 apply, it seems it really should be a consideration to treat the trading like the business it really is. In my case...it's been a good while since I've had net losses, I have little in business expense (although could probably consider home office), I have just a few wash sales, but I have quite a bit of margin interest each year.
Some may have very good reasons to form an entity, but I would think that most full-time traders need not consider doing so.
Thoughts?
http://www.marketwatch.com/story/tax-strategies-for-day-traders-2015-02-25?link=MW_latest_news
The article makes it seem rather simple. According to the article, the trader simply adds a Schedule C to the return with a letter of explanation, and on the Schedule C will go the business expenses and margin interest. The advantage is in the treatment of the expenses on the Schedule C, and the treatment bypasses the usual limit of 2% of AGI while reducing AGI.
The article also states the added benefits of becoming a "mark-to-market" trader, which eliminates wash sale rules, as well as the $3000 limit for capital gains losses. It appears Part II of Form 4797 is the form to utilize for gains and losses for "mark-to-market" trading.
So if the trader has little business expense, no margin interest, no wash sales, and net profits on the year, there is really no benefit to TTS. But if any of those 4 apply, it seems it really should be a consideration to treat the trading like the business it really is. In my case...it's been a good while since I've had net losses, I have little in business expense (although could probably consider home office), I have just a few wash sales, but I have quite a bit of margin interest each year.
Some may have very good reasons to form an entity, but I would think that most full-time traders need not consider doing so.
Thoughts?
Robert Morse
Sponsor
Why not do both if it applies? LLC with MTM accounting if it fits your buiness.
I think you are right. I would claim trader tax status, not form an entity, and not elect MTM accounting. You can write off your margin interest expense on Schedule C. The only tricky part is that having only expenses shown on your Schedule C is a red flag for the IRS. You have to zero out your Schedule C expenses with your trading profits. But they are on Schedule D/Form 8949. I would buy Green Trader Tax's guide for an example on how to do this transfer (or try to find an example somewhere online). In the end, your Schedule C should show 0 profit, i.e., not negative. Because your Schedule C total is 0, it also conveniently takes care of the social security/unearned income issue that traders have. I.e., you won't pay any social security tax (which is correct because trading income is classified as unearned income).
Forming an entity, although it can unlock some earned income, increases compliance complexity and could also increase data fees. I.e., you might have to start paying professional data fees if you are trading under an entity business account.
Robert Morse
Sponsor
Not sure what you are referring to with," unlock some earned income, increases compliance complexity ", but you are right about professional data fees. You will have to pay them.
That's what I did and it seems to work. After the first audit a few years ago the IRS has not bothered me since. I did (and do) keep good records and go show every trade for every day, costs associated with each trade (Commissions, NFA regulatory fee, CME fee, etc.)
Clarification: if you are an individual trader (i.e., sole proprietor, no business entity), your trading income is considered unearned income. In order to "unlock earned income," you would need a business entity so that you can pay yourself a salary. Creating a business entity is a more complicated structure than a sole propietorship, in terms of tax compliance.
Robert Morse
Sponsor
Thank you for the clarification. A sole member LLC is a disregarded entity. It is a more complicated but provides some protection for your personal assets and creates a structure that many tax specialist recommend.
https://www.irs.gov/businesses/smal...ited-liability-company-possible-repercussions.
This is very popular but you should consult a tax specialist to make sure you set this up properly and it is right for your business.
comagnum said:
Trader Status has some serious pitfalls as compared to structuring as a business.
Check out this article:
https://andersonadvisors.com/trader_taxation/
But the article makes some good points as far as wanting trader status. I didn't know, for example, that you have to claim "mark to market" status prior to the year you want to do it. It's true that traders a) can avoid wash sales, and b) don't plan to lose at their business. So being able to deduct expenses without dealing with the 2% AGI floor seems to be the best reason for wanting trader status...and really only if the trader has meaningful expenses. Would you agree?
And can you point out the positive aspects of setting up an LLC, aside from having asset protection?
Trader Status has some serious pitfalls as compared to structuring as a business.
Check out this article:
https://andersonadvisors.com/trader_taxation/
Thanks, Robert. I suppose I'll look into setting up an LLC. Having asset protection is a plus.
But the article makes some good points as far as wanting trader status. I didn't know, for example, that you have to claim "mark to market" status prior to the year you want to do it. It's true that traders a) can avoid wash sales, and b) don't plan to lose at their business. So being able to deduct expenses without dealing with the 2% AGI floor seems to be the best reason for wanting trader status...and really only if the trader has meaningful expenses. Would you agree?
And can you point out the positive aspects of setting up an LLC, aside from having asset protection?
Thanks, sprstpd. From what I've read, though, it seems that you can have Schedule C show just expenses and be negative so long as there is a letter of explanation. And if I'm correct, that would negate the social security tax concern.