Tax Benefits of Starting a LLC or Corp for Retail Trader

[Bob111]

Quote from IAS_LLC:

Near the bottom of the page:

WHAT DOESN'T QUALIFY?
There are three factors that automatically don’t qualify for trader tax status:
1. Automated trading without much involvement by the trader.
2. Engaging a money manager.
3. Trading retirement funds.

feel free to ask Green about it. see reference to original IRS link above

read more from links on first page to get an idea what trader status and M2M accounting gives you. main benefit of all this is ability to write off losses(not 3K per year when you file in your personal taxes)
and wash sales(dunno what you planning to trade)

 

[Bob111]

Quote from IAS_LLC:

Its not a "fire and forget" automation, I will be there making sure nothing goes haywire, but the software is making the trading decisions

i've been there and understand that. and so should IRS

 

[blah12345678]

First off, you only have $20K. Prove your system works first. Whatever returns your system generates will most likely not compensate you for the time, money, and complications you introduce pursuing biz structure/tax savings.

Build the business first, then worry about maximizing tax savings/minimizing liability and exposure once you're system generates significant returns consistently.

Consider it "exploratory" R&D to prove the idea is feasible...

Afterwards, there are 2 vendors who specialize in trading taxation - Green CPA and one other. In the US, you do not need a tax specialist in your own locale. Any reputable specialist who's accessible via phone/email/fax is the best choice, not the local H&R Block or tax return processing practice.

Regarding LLC, always try to find a 2nd person (for example, gift your SO, parents, or siblings a 5% interest) so you qualify as a partnership and qualify to file Schedule E and Schedule K-1. You want to avoid filing a Schedule C. The Schedule E/K-1 combo is key. The IRS has a hard time matching E's to K-1's, so your audit risk drops to low single digits.

Filing a Schedule C is for suckers - the IRS wants people to file Schedule C's because they're the uninformed low-hanging fruit they can bully and beat up. High reward/low risk for the IRS.

 

[jeb9999]

Quote from IAS_LLC:

Hello,

I am a relatively small retail trader (~$20k) who was been developing some automated algorithmic trading software over the last couple years that I am getting ready to take live in the coming months. My strategies are geared towards the Globex Futures market (I know that is relevant for tax purposes).

As a retail trader, are there any benefits from a tax stand point (or any other standpoint) to forming a LLC or corporation for my trading activities as opposed to just operating a personal retail account as a I am currently doing?

It is my understanding that as an individual, profits from futures trading is taxed 60% at the short term capital gains rate, and 40% at the long term capital gains rate. Do corporations or LLCs get a better deal (i.e 100% at the short term rate..... or worse, 100% a the corporate income tax rate)? LLCs and S-Corps are set up as pass through tax entities, so does this mean If I make some profit trading futures, these profits are passed onto me and taxed at my personal income tax rate, or can I still treat them as capital gains?

Futures trading profits are taxed 60/40 meaning 60% Long Term and 40% Short Term.

For small retail traders worrying about tax benefits is a waste of time. Making money should be your prime focus. Don't let the tax tail wag the trading dog. Let's say you have annual expenses of $1000 you can't deduct. If you are in the 25% bracket you lose out on $250. I'd rather lose the $250 than have to pay a lawyer and CPA for a structure and deal with it every year. You just got a major tax benefit by deciding to trade futures.

If you are going to be "super active", how many round turns a month are you going to do? Unless you have a decent profit per trade the exchange fees and commissions are going to eat up your account.

Normally a very active futures trader would lease or buy a seat to minimize exchange fees and to negotiate better commission rates, but that is a real problem for a trader with only a $20K account.

When you start making large profits you can set up a structure and lease or buy an exchange seat. Note that becoming an exchange member subjects your futures trading profits to FICA taxes.

 

[wartrace]

Quote from IAS_LLC:

Near the bottom of the page:

WHAT DOESN'T QUALIFY?
There are three factors that automatically don’t qualify for trader tax status:
1. Automated trading without much involvement by the trader.
2. Engaging a money manager.
3. Trading retirement funds.

How does the IRS know it is automated? Can't a trader claim the trades are automated but supervised? It could be argued that the trader doesn't "trust" the automation and thus requires constant monitoring of the system.

 

[Bob111]

Quote from wartrace:

How does the IRS know it is automated? Can't a trader claim the trades are automated but supervised? It could be argued that the trader doesn't "trust" the automation and thus requires constant monitoring of the system.

yep..i really like to know how Mr Green come up with it.
i kind of know what to expect,but i would appreciate an explanation from primary source.

 

[kid.fx.cross]

Quote from IAS_LLC:

Hello,

I am a relatively small retail trader (~$20k) who was been developing some automated algorithmic trading software over the last couple years that I am getting ready to take live in the coming months. My strategies are geared towards the Globex Futures market (I know that is relevant for tax purposes).

As a retail trader, are there any benefits from a tax stand point (or any other standpoint) to forming a LLC or corporation for my trading activities as opposed to just operating a personal retail account as a I am currently doing?

It is my understanding that as an individual, profits from futures trading is taxed 60% at the short term capital gains rate, and 40% at the long term capital gains rate. Do corporations or LLCs get a better deal (i.e 100% at the short term rate..... or worse, 100% a the corporate income tax rate)? LLCs and S-Corps are set up as pass through tax entities, so does this mean If I make some profit trading futures, these profits are passed onto me and taxed at my personal income tax rate, or can I still treat them as capital gains?

One downside that I can think of to incorporating would be that I would likely have to pay "Professional" data fees.

One upside would be that I could start building a track record if for some reason in the future I wanted to seek outside investors (I have no intention of selling my software or seeking outside money right now or in the foreseeable future, but I like to consider all options all of the time)

What other benefits are there to incorporating (or forming LLC) for a "successful" retail trader?

If it matters, I do have a day job (not trading....engineering stuff) and have no immediate plans to leave that job.... but I would be lying if told you that it isnt a dream of mine to trade for a living.

What are your thoughts?



Thanks!!
Brad

if you have a real job, you already have what most traders are looking for and that would be earned income. If you incorporate or form an LLC, you will get earned income which with a real job you don't need, and then also have to pay self employment tax on your "investments" which is what the IRS considers your trading account which is currently exempt. And you are right, with a 20k account, the "professional" data feeds could be a real bitch. If you are looking to attract outside investors just keep your trading account separate from all your personal investing.

 

[IAS_LLC]

All,

It sounds like just keeping my trading as an individual is the best way for me to go right now.

This is a silly question, but my trading profit tax liabilty at the end of the year includes the cost of 100% of my data feeds and commissions right? Up until this year, my trading profits have been miniscule so I haven't claimed them on my returns.


For example, if I made 1 round trip trade
Bought XYZ for $10
Sold XYZ for $20
Paid $9 in commission
and Paid $1 for a data feed,

My trading tax liability would be zero, right?

I value all of your insight/patience!!

Thanks,
Brad

 

[blah12345678]

Quote from IAS_LLC:

All,

It sounds like just keeping my trading as an individual is the best way for me to go right now.

This is a silly question, but my trading profit tax liabilty at the end of the year includes the cost of 100% of my data feeds and commissions right? Up until this year, my trading profits have been miniscule so I haven't claimed them on my returns.


For example, if I made 1 round trip trade
Bought XYZ for $10
Sold XYZ for $20
Paid $9 in commission
and Paid $1 for a data feed,

My trading tax liability would be zero, right?

I value all of your insight/patience!!

Thanks,
Brad

Nope, you have a taxable gain of $1. You get to eat your hobby's expenses...

 

[wartrace]

If you meet the IRS's definition of a "Trader" you could deduct all your expenses.

One thing that concerns me with forming an LLC to trade is you would have to deal with payroll tax. If you have a pass through entity you are an employee and any salary you draw would be subject to both sides of the payroll tax (over 14%)

I am not a tax accountant so take what I say with a grain of salt.

From my understanding a trader that makes daily trades and derives the majority of income from trading would qualify as a "trader".