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Prior to 1934, a trader in
securities was taxable on the gains derived from his trading activities
as ordinary income. Such gains were excluded from the capital gains
provisions of the IRS Code because "capital assets" were defined as not
including "property held by the taxpayer primarily for sale in the
course of his trade or business."
Then in 1934 Congress amended IRS Code §117 to treat securities trading
as transactions in capital assets in order that losses incurred in these
transactions could not be deducted in full. The Revenue Act of
1934 amended the definition of "capital asset" in the new IRS Code §117
so as to exclude, not all property held primarily for sale in the
course of business, but now to exclude only such property as was
held primarily for sale "to customers" in the "ordinary" course of
business. Since the sale on a securities exchange is not usually
considered to be a sale "to customers," it was asserted that this
amendment made it "impossible to contend that a stock speculator trading
on his own account is not subject to the provisions of §117" or, to
state it in the positive, that from then on a stock speculator trading
for his own account would be subject to capital gain and loss treatment
under IRS Code §117 unless he first properly elects the mark-to-market
provisions under IRS Code §475.
Taxpayers who qualify to file as
Trader Status may
optionally elect in advance, by a filing with the IRS, to irrevocably
use as their accounting system the "Mark-to-Market" method under IRS Code §475 for the
election year and all ensuing years, as described on this web site. This
accounting method treats what would normally be Schedule D "capital
gains and losses" as Form 4797 "ordinary gains and losses."
Some other features of Mark-to-Market are: (see Non Mark-to-Market
Trader for different features)
- Effective for
years 2011 and thereafter, the complicated reconciliation of
IRS form 8949 and the broker issued form 1099-B is avoided.
- If the M2M election was
filed previously, the year's
net trading losses are "ordinary losses" and
are therefore not limited to the annual $3,000
"capital loss" limitation. They are
generally fully deductible and they reduce your taxable income from all
other sources. The year's net trading losses do not get added to any
existing balance of your prior years' capital loss carryforwards.
- The year's
net trading gains are "ordinary gains" and
are therefore not available to offset against any old prior
years' "capital loss" carryforwards.
- The year's net trading
gains, while taxed as "ordinary," are
nonetheless not subject to
Self-Employment tax under IRS Code §475(f)(1)(D) (but they are of
course subject to your regular federal income tax rates).
- Since net trading gains are
not subject to Self-Employment tax no deduction for an IRA or other
Retirement plan or Health Insurance plan may be directly
based on them.
- The year's net trading gains
are usually taxed at your regular ordinary rates. The
capital gains tax rates are not applied to your trading gains.
Although securities separately held for investment may be subject
to the capital gains tax rates upon sale.
- The year's net trading gains
in §1256 contracts (futures) are usually taxed at your regular ordinary rates. The
special 60/40 capital gains tax rates are not applied to your
trading gains. Although §1256 contracts separately held may be
subject to the preferential 60/40 capital gains tax rates. (note:
the §475 election for futures is separate and apart from the §475
election for securities).
- The year's net trading gains
in each specific §988 transaction (FOREX) is usually taxed as a
regular §1256 contract if you elected under §988(a)(1)(B) by the end
of the day that the position was opened, pursuant to §988(c)(1)(B)(iii)
- Stocks that are so identified are subject to
mark-to-market while other stocks specifically
identified as being held solely for investment
purposes are not subject to the mark-to-market
accounting and tax treatment.
- The Wash
Sales rules are ignored for these securities.
- A wife may
elect Mark-to-Market, while her husband might
not.
- Securities
held overnight on December 31st are
accounted for "as sold" and the paper gains or losses are shown on the current year's
tax return. For the first year that a trader
elects to change to the mark-to-market method
some of the current year's net gains (or in limited
circumstances, losses)
may be limited to being recognized approximately at
the rate of 25% per year over four years. This
four-year rule holds true even if in the
following year the taxpayer realizes significant
net losses (or gains).
- If you properly elect
mark-to-market between January 1, 2006 and April 15, 2006 this
will convert any Capital Losses on trading securities held at December 31,
2005 into deductible Ordinary Losses. This will also convert
most disallowed wash-sale Capital Losses from December 2005 to
fully deductible Ordinary Losses in 2006. These Ordinary
Losses would be fully deductible either as straight losses in
2006, subject to a two year NOL carryback (was five years for 2001 &
2002 and is planned again for 2007 & 2008), and/or deductible over (one/four years
if prior to 2004) or one year pursuant to IRS Code §481.
- Sole proprietors report expenses (which generally includes
margin interest) on
Schedule C and trading
activity (which generally includes the commissions thereon) on
Form
4797, (see
instructions
pages 2 & 4 & 6).
- Sole proprietor M2M traders
are exempt from the new 2005 rule for individuals that each sale be
listed directly on an
IRS Schedule D-1 rather than attaching a supporting statement to
the tax return (Quicken report, Excel, Broker provided report, etc.)
- Partners, LLC members and S-Corp shareholders report passthru
amounts on
Schedule E and other tax forms.
- Partners, LLC members,
S-Corp shareholders and C-Corp shareholders may be subject to
Self-Employment tax and therefore may be able to have a deduction
for a Retirement plan or Health Insurance plan.
- In general, capital gain vrs.
ordinary income may be recharacterized under §§475(f), 988, 1258 or
1296.
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