Trade as Business vs. Trade Personal Account

[crackedback]

I guess the peril of MTM election depends upon the instruments you trade. It isn't for everyone.

Filing MTM doesn't make you trader status. That's the other issue I mentioned regarding the peril statement.

You can deduct expenses on a Sch C without being MTM. Whoever told you you couldn't is mistaken.

 

[kjkent1]

Quote from crackedback:

I guess the peril of MTM election depends upon the instruments you trade. It isn't for everyone.

Filing MTM doesn't make you trader status. That's the other issue I mentioned regarding the peril statement.

You can deduct expenses on a Sch C without being MTM. Whoever told you you couldn't is mistaken.

OK, I've looked up the relevant law, and I have what I believe is a fair interpretation.

1. The MTM allows the taxpayer to treat all trading gains/losses as if the trader had liqudated all positions for cash at the end of every tax year.

2. Making the MTM is not required in order to use Sched C, however, failure to make the election, or at least to change the taxpayer's accounting method, could be used as evidence to rebut the assertion that they are actually a trader. That is to say, if you're trading, then you should be looking to recognize short term income, by reconciling all short and long positions at the end of every trading day, and not making the election is not consistent with someone looking to recognize short term income. Rather, it is consistent with someone who is an investor, and who is seeking to defer taxes on long term investments.

3. 26 U.S.C. 475(f)(3) states: "The elections under paragraphs (1) and (2) may be made separately for each trade or business and without the consent of the Secretary." This actually indicates that the trader has no legal obligation to inform the IRS commisioner of the change in accounting, because if the failure to notify the IRS of one's making the election is sufficient to invalidate it, then that would be the exact equivalent of having to obtain the IRS commissioner's advance consent. Moreover, it appears that if the taxpayear files a return using MTM accounting, the taxpayer is impliedly giving notice of his/her intent to use such accounting.

And, this is despite the existence of IRS ruling 99-17 -- although, if you're not an attorney, it's probably not worth the risk of not formally making the election -- but I'm pretty certain I could beat the IRS on this issue.

Anyway, you're technically correct about the Schedule C issue. Nice catch.

 

[joeyata1]

i've been a mtm trader for 3 years and bfore that trader status 2 years.YOU DO NOT HAVE TO ELECT MTM TO WRITE OFF YOUR EXPENSES ON SCH C.the year someone is a trader they simply file as a trader in securities. there is no form to fill out. heres the procedure to elect mtm. by april 15th of the tax year you msut elect mtm status. you simply send a note in with your previous years tax return or with an extension and state you are electing mtm status for tax year 2005. the reason they require you to do by april 15th of the present year is you could wait till year end and have a huge lose and say i have to do mtm. the irs makes you take a risk up front. the other major benefift of mtm is no wash rule and 1 line accounting of the total buys and sells for the whole year. now you can do 1 line accounting with trader status but the irs could challange it and say itemize every line and show us your profit and we want to see any wash sales. will they do that? i'd say about 1 in 5000 chance they'd do that. i scoured every detail of every tax return green trader did for me and asked 1000 questions so i feel i know every single law and proper way to do a trader tax return. the reasons i enver did my own are a few #1 my tax software could enver show billions in sales it didn't have enough zero's and the msot important one is green trader sued 3 pages of foootnotes explaining exactly what they were doing to head of any confusion or a possible audit. its worth 800-1000 bucks for peace of mind

 

[crackedback]

Quote from kjkent1:

OK, I've looked up the relevant law, and I have what I believe is a fair interpretation.

1. The MTM allows the taxpayer to treat all trading gains/losses as if the trader had liqudated all positions for cash at the end of every tax year.

2. Making the MTM is not required in order to use Sched C, however, failure to make the election, or at least to change the taxpayer's accounting method, could be used as evidence to rebut the assertion that they are actually a trader. That is to say, if you're trading, then you should be looking to recognize short term income, by reconciling all short and long positions at the end of every trading day, and not making the election is not consistent with someone looking to recognize short term income. Rather, it is consistent with someone who is an investor, and who is seeking to defer taxes on long term investments.

3. 26 U.S.C. 475(f)(3) states: "The elections under paragraphs (1) and (2) may be made separately for each trade or business and without the consent of the Secretary." This actually indicates that the trader has no legal obligation to inform the IRS commisioner of the change in accounting, because if the failure to notify the IRS of one's making the election is sufficient to invalidate it, then that would be the exact equivalent of having to obtain the IRS commissioner's advance consent. Moreover, it appears that if the taxpayear files a return using MTM accounting, the taxpayer is impliedly giving notice of his/her intent to use such accounting.

And, this is despite the existence of IRS ruling 99-17 -- although, if you're not an attorney, it's probably not worth the risk of not formally making the election -- but I'm pretty certain I could beat the IRS on this issue.

Anyway, you're technically correct about the Schedule C issue. Nice catch.

1. True... Changes the character of gains from Cap to Ordinary Income. Subject to the other lovely taxes.

2. False... There are cases where a "trader" would NOT want to go MTM which have been hashed over and over in these Forums. If you can present an effective case where a profitable "futures trader" would benefit from MTM, I'm all eyes and ears. It's all about the instrument, IMHO.

The IRS has cracked down on trader status filings. It is in excess of the 2% general population audit risk. I believe the 2% number includes all those folks filing 1040-ez's, etc. who have little to no risk of audit unless you claim 90 kids as dependents.

 

[kjkent1]

Quote from crackedback:

1. True... Changes the character of gains from Cap to Ordinary Income. Subject to the other lovely taxes.

2. False... There are cases where a "trader" would NOT want to go MTM which have been hashed over and over in these Forums. If you can present an effective case where a profitable "futures trader" would benefit from MTM, I'm all eyes and ears. It's all about the instrument, IMHO.

The IRS has cracked down on trader status filings. It is in excess of the 2% general population audit risk. I believe the 2% number includes all those folks filing 1040-ez's, etc. who have little to no risk of audit unless you claim 90 kids as dependents.

Regarding IRS crackdowns, if you have specific evidence of this, I'd like to read it. Unsubstantiated rumors about IRS crackdowns are always floating and the IRS never comments, because this is part of the method by which the gov. obtains voluntary compliance. But, audits are completely irrelevant to anyone who correctly reports their income and expenses. Auditing a trader is actually a pretty simple project for an IRS agent, because all of the trades are available from the trader's brokerage. If you don't screw up your accounting, then the auditor will come back with the same numbers as you.

The only areas for argument are non-trading issues, such as business seminars in Vegas or the Caymans, etc. And, those areas are no less suspect for a trader than for an accountant or a doctor.

Regarding your suggestion that I tell you why a future trader would want to make the MTM election, I don't really know the rationale for arguing the issue either for or against.

So, if you want me to make an argument in favor of the MTM election, you'll have to tell me first what advantage you believe is gained by not making the election.

None of this tangential discussion, by the way, changes any of the advice that I gave to Mr. Clark, earlier. There is no value that I can see for the average trader to create an LLC or any other legal entity for the purposes of trading.

 

[Sparohok]

Quote from kjkent1:

There is no value that I can see for the average trader to create an LLC or any other legal entity for the purposes of trading.

Apart from the benefits you listed earlier in the thread:

1) An entity can elect MTM internally when it is created, at any point in the tax year, which is a way to get around the April 15 deadline.

2) It is difficult for an individual to go back from MTM to cash method of accounting, whereas an entity can simply stop doing business.

3) Your entity can pay you earned income in order to deduct health insurance premiums and retirement plan contributions.

And a disadvantage: a brokerage account opened by an entity will be charged professional rates for real time market data.

That's all I can think of, but I'm sure there's more at greencompany.com.

Martin

 

[kjkent1]

Quote from Sparohok:

Apart from the benefits you listed earlier in the thread:

1) An entity can elect MTM internally when it is created, at any point in the tax year, which is a way to get around the April 15 deadline.

2) It is difficult for an individual to go back from MTM to cash method of accounting, whereas an entity can simply stop doing business.

3) Your entity can pay you earned income in order to deduct health insurance premiums and retirement plan contributions.

And a disadvantage: a brokerage account opened by an entity will be charged professional rates for real time market data.

That's all I can think of, but I'm sure there's more at greencompany.com.

Martin

1. True, although, I'm pretty certain that IRS Ruling 99-17, which requires the election by 4/15, is an unlawful reg. But, that's another issue.

2. What evidence do you have to support this statement? The only requirement from the IRS is that the taxpayer request the accounting change. There would be no justification whatsoever for the IRS to deny such a request if the taxpayer is not operating as a trader.

Additionally, the cost of starting a corp, maintaining it and then winding it up is not trivial.

3. This would also cause you to have to pay unnecessary payroll and social security taxes. FAR better to just set up a Heathcare Savings Account and take the self-employed healthcare deduction.

 

[Sparohok]

Quote from kjkent1:

2. What evidence do you have to support this statement? The only requirement from the IRS is that the taxpayer request the accounting change.

http://www.irs.gov/publications/p550/ch04.html

"Once you make the election, it will apply to 2005 and all later tax years, unless you get permission from IRS to revoke it."

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

"Once you make the election, you have to continue to use the mark-to-market method for all future years. You can change the election only with the consent of the Internal Revenue Service, and they generally won't grant this consent if your reason for changing is simply that the election didn't turn out to your advantage."

3. This would also cause you to have to pay unnecessary payroll and social security taxes. FAR better to just set up a Heathcare Savings Account and take the self-employed healthcare deduction.

There is no legal way to deduct health insurance without incurring payroll taxes.

http://greencompany.com/EducationCenter/GTTRecHealthInsurance.shtml

HSA contributions and health insurance premiums are deductible only from earned income. A sole proprietor trader with no other business will have no earned income. One way to generate earned income from trading is to have an entity and pay yourself a salary.

By the way, I'm not saying every trader needs an entity, and I am well aware of the disadvantages. I just wanted to clarify the advantages.

Martin

 

[kjkent1]

Quote from Sparohok:

http://www.irs.gov/publications/p550/ch04.html

"Once you make the election, it will apply to 2005 and all later tax years, unless you get permission from IRS to revoke it."

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

"Once you make the election, you have to continue to use the mark-to-market method for all future years. You can change the election only with the consent of the Internal Revenue Service, and they generally won't grant this consent if your reason for changing is simply that the election didn't turn out to your advantage."

There is no legal way to deduct health insurance without incurring payroll taxes.

http://greencompany.com/EducationCenter/GTTRecHealthInsurance.shtml

HSA contributions and health insurance premiums are deductible only from earned income. A sole proprietor trader with no other business will have no earned income. One way to generate earned income from trading is to have an entity and pay yourself a salary.

By the way, I'm not saying every trader needs an entity, and I am well aware of the disadvantages. I just wanted to clarify the advantages.

Martin

As for having to revoke the election, there's really no need. If you want to retain the benefits of long term investment, you need merely indicate in your accounting records that you are acquiring a security as a long-term investment, rather than a short term trade. (see 1040 instructions, page D-3).

As for contributing to an Heath Savings Account, there is no requirement that the contributions come from "earned income." (see Publication 969).

As for the self-employed health care deduction, you are correct that the premiums must be deducted from earned income. (see Publication 535).

 

[SteveD]

Questions:

If I elect MTM and also hold a stock for over a year would not my capital gains be long term on that particular stock? Even if I do some daytrading, some short term swing, and some longer position trading (less than 1 yr). Also, avoiding "wash sale" issue.

Doesn't the problem with MTM come in when you have real money losses and want to deduct more than the $3000 limit? If you are profitable it is not much of an issue is it?

I have always believed in separate stand alone entities for each venture I invest in. I have always used a Subchapter S Corp. For example: I fund SteveD Trading Inc. with $25,000 and enter the fabulous business of stock trading. Five years from lnow I have $500,000 in that company from my great talent for picking winners only, LOL. That year I bump into the side of someone's car and they decide to sue me. My $500,000 is protected. The minor cost of setup, maintaining, reporting etc is well worth it to protect it.

Thoughts or comments are welcome. We do have spell check for those of us that are challenging

SteveD