Trader Status Tax Questions

[catmango]

I plan to file my 2003 return with "trader status", though only as a sole proprietor (i.e., I'm not making enough to justify a LLC). Now, I read the March & April 2003 articles by Robert Green in Active Trader magazine, which discuss at length the filing approach of a sole proprietor. I have three questions:

1) Where on the 1040 do I claim "trader status"?

2) If after every trading day I get together with my trading friends for lunch to talk about the day's trades and to refine our strategies, is the meal and car mileage considered allowable deductions? This could potentially total upwards of $5k for the year (obviously subject to the 50% rule).

3) Green noted that in a sole proprietorship, all trading expenses would be reported on the Schedule C and all trading profits would be reported on the Schedule D, but he then says to "transfer whatever you can from Schedule D ... to Schedule C to cover all your Schedule C expenses, plus your allowable home-office expenses and allowable Section 179 depreciation expenses." He also says "it is important to attach a footnote to your tax return to explain what you have done and why...It is permissible to combine these schedules for tax purposes." My question is this -- I don't see any specific lines on Schedules C or D that permit a transfer of gains from one to the other, so how would I show this? (if you can provide specific lines on the forms, that would be very helpful.)

Unfortunately, I'm not making oodles of dough just yet, so I'm still filing myself (i.e., I can't hire a CPA with trader status expertise). So, any free advice would be greatly appreciated.

 

[jessie]

Trader is listed as one of your occupations (it doesn't have to be the only one) on the 1040. As for whether you will qualify, you will have to be able to demonstrate the requirements below. I would doubt seriously that meals or coffee with friends, unless they are securities professionals also, would qualify, but it's your tax return (deductions for business dinners have been limited for a while now anyway). My own feeling about trader CPAs is that if you are making enough to consider trading as an occupation, then you will probably save the price of a CPA a few times over, if not in taxes, then in penalties or in expenses saved by your loved ones not having to come visit you in federal prison for tax fraud, or at the very least in not having to deal with an audit because you tried to do something strange but legal (e.g. typical trader's return) and didn't quite pull it off. You also talked about not doing much size yet, and one thing to consider is that dollar amounts of trades are one of the things expressly considered in determining whether you qualify. If you are trading a 5 or 10K account, that is likely to create a problem if it is scrutinized. As it says below, you must meet ALL of the conditions listed in IRS 429.

Anyhow, the complete description is under Rule 429 and can be found at:

http://www.irs.gov/taxtopics/page/0,,id=105556,00.html

Jessie
P.S. Go Cubs and CONGRATULATIONS BADGERS!!

From 429:

"Special rules apply if you are a trader in securities, in the business of buying and selling securities for your own account. To be engaged in business as a trader in securities, you must meet all of the following conditions:

You must seek to profit from daily market movements in the prices of securities and not from dividends, interest, or capital appreciation.
Your activity must be substantial, and
You must carry on the activity with continuity and regularity.

The following facts and circumstances should be considered in determining if your activity is a securities trading business:

Typical holding periods for securities bought and sold.
The frequency and dollar amount of your trades during the year.
The extent to which you pursue the activity to produce income for a livelihood, and
The amount of time you devote to the activity.

If the nature of your trading activities do not qualify as a business, you are considered an investor, and not a trader. It does not matter whether you call yourself a trader or a "day trader." Further, a taxpayer may be a trader in some securities and hold other securities for investment. The special rules for traders do not apply to the securities held for investment. A trader must keep detailed records to distinguish the securities held for investment from the securities in the trading business. The securities held for investment must be identified as such in the trader's records on the day he or she acquires them.

Traders report their business expenses on Form 1040, Schedule C (PDF), Profit or Loss From Business. The limit on investment interest expense, which applies to investors, does not apply to interest paid or incurred in a trading business. Commissions and other costs of acquiring or disposing of securities are not deductible but must be used to figure gain or loss upon disposition of the securities. Gains and losses from selling securities as part of a trading business are not subject to self–employment tax."

 

[catmango]

Thanks for the info. This year so far I've conducted 650 round trip trades, trading a total of 250k shares with a value of $5.4M. I'm hoping that that's enough to be considered an active trader (especially since I've relied entirely on my gains to pay the bills this year so far!).

I found a thread posted by Robert Green that explains (sort of) the concept of transfering over the gains from Schedule D to C. It's at http://www.elitetrader.com/vb/showthread.php?s=&postid=319702#post319702.

As far as hiring a CPA, hopefully by next 4/15 I'll have enough capital to spend on one.

Any other opinions on meals and entertainment are welcome!

 

[lindq]

Quote from rolegario:

Thanks for the info. This year so far I've conducted 650 round trip trades, trading a total of 250k shares with a value of $5.4M. I'm hoping that that's enough to be considered an active trader (especially since I've relied entirely on my gains to pay the bills this year so far!).

I found a thread posted by Robert Green that explains (sort of) the concept of transfering over the gains from Schedule D to C. It's at http://www.elitetrader.com/vb/showthread.php?s=&postid=319702#post319702.

As far as hiring a CPA, hopefully by next 4/15 I'll have enough capital to spend on one.

Any other opinions on meals and entertainment are welcome!

An important issue is whether or not you are working at another occupation. If you are, then your trader status will probably not cut it with the IRS. But f you are living on your trading income, 650 trades should easily be enough to qualify as a "trader in securities".

Regarding your deductions for meals and meetings, it is best not to push unless they can be easily defended. My guideline has always been, if I were sitting in an IRS audit - and I have in the past - would I feel comfortable defending this expense? If in doubt, leave it out.

 

[jessie]

Actually, not being able to have another job is a common misconception. Having another job really isn't a problem for trader tax status, as long as you meet the other criteria. I know a number of people who do so, and I did for a number of years as well with no problems. It is really important, though, especially if that is the case, to make sure that your trading "business" really is a business, and is run like one. You had better have good books, a separate bank account, impeccable records, and look like at least the start of a real trading business. You don't have to make a profit initially, but if you are deducting expenses, and you get audited, you had better look like you are professional and intending to make one soon. The key seems to be whether you really meet the IRS stated criteria, which can be done with or without a job and additional W2s. I agree wholeheartedly about not pushing the lunch deductions, though, especially if you don't want everything looked at and gone through with a fine-tooth comb. Once you open that door.......
Good Trading, and GO CUBS!
Jessie