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  Copyright© 1999 to 2014 Colin M. Cody, CPA and TraderStatus.com, LLC, All Rights Reserved.
  For IRS tax purposes a Trader might operate as a "trade or business" if the intent is to profit from market price swings as the primary source of income for the year.  With this as the intent, then once the taxpayer's activity rises to a sufficient level it may be taxed under trader status rather than, by default, as an investor (investor status).

For the trade or business to gain Securities Trader Status or Financial Instruments Trader Status or Commodities Trader Status with the IRS it might buy and sell Stocks, Stock options, Bonds, Futures, Commodities, E-mini's, QQQQ options, §1256 contracts, foreign currency contracts and so on.

Generally speaking to have Trader Status your activity must be substantial. and you must carry on the activity with continuity and regularity.

Per an IRS audit/examination guide, you must not have any interest in "capital appreciation" or even in "conservation of capital."  While it is true that generally a knowledgeable business person should probably have money management as a major concern, it is a fact that IRS agents have these instructions in their audit guides.

Avoid tax return preparation "errors" that the IRS is wise to.  Some preparation firms make extra money handling the IRS inquiries and examinations resulting from such "unintentional" oversights.  We feel that it is best to do it right the first time and avoid questions from the IRS.

Beware of these common misconceptions:
Please note that obtaining "trader status" alone results in no change from the norm for reporting your gains and losses - which is to say, they remain Schedule D capital gains and losses.  If you wish to obtain Form 4797 ordinary gains and losses you must further elect "mark-to-market" under stringent rules.

Please note further that once obtaining "trader status" with or without  having elected "mark-to-market" that the security trades must still be accounted for by matching purchases and sales on a FIFO basis (unless "versus purchase" is stated at the time of sale) and listing "each" "matched" "transaction" in a format similar to what is found on IRS Schedule D.   This reporting format does not change whether the trader is an individual person, a LLC, or a corporation.

Individuals and most Individually owned SMLLCs:

  • Under audit, it should be evidenced that the taxpayer had a substantial portion of his liquid net worth trading the market.   Ideally even using margin.
     
  • There should be monthly sells.  preferably weekly sells, even more preferably daily sells.
     
  • There should probably be at least 200 to 500 significant sells per year with a minimum of maybe 1/36th of the year's number of sells occurring in each month.  Ideally, each week should see some selling.
    • Traders with 1,000 or more significant sells per year usually clearly qualify for trader status.
    • Traders with less than 100 or 200 sells may have a tougher time substantiating trader status.1
    • Traders with significant sells numbering between 200 and 500 or 1,000 often can qualify for trader status but they might be under more scrutiny during an audit than would someone with more significant volume.
       
  • The typical holding period for most sells should be four months or less, preferably one month or less, even more preferably one week or even daily.
     
  • The taxpayer should spend a good part of most every day watching and trading the markets during trading hours.
     
  • The taxpayer should be looking for this activity to be the primary way to provide his livelihood. i.e. he should avoid having a "regular day job."
     
  • The taxpayer should maintain a business-like operation: good books and records, continuing education books and seminars and so on.
     
  • It can be said that a better rule of thumb is to only claim trader status as an individual reporting income on tax form 1040 whenever the activity is your only job and you have no other funds available to support yourself with.  Otherwise form a separately filing entity that will not use form 1040
     



Entities (including SMLLCs) filing separate tax returns:

  • Under audit, it should be evidenced that the trading entity had all it's capital in the market and was actively trading it.  Ideally even using margin.
     
  • There should be monthly sells.  preferably weekly sells, even more preferably daily sells.
     
  • There should probably be at least 100 to 300 significant sells per year with a minimum of maybe 1/36th of the year's number of sells occurring in each month.  Ideally, each week should see some selling.
    • Traders with 750 or more significant sells per year usually clearly qualify for trader status.
    • Traders with less than 100 or 200 sells may have a tougher time substantiating trader status.
    • Traders with significant sells numbering between 100 and 500 or 750 often can qualify for trader status but they might be under more scrutiny during an audit than would someone with more significant volume.
       
  • The typical holding period for most sells should be four months or less, preferably one month or less, even more preferably one week or even daily.
     
  • The entity should spend a good part of most every day watching and trading the markets during trading hours.
     
  • The entity especially should maintain a business-like operation: good books and records, continuing education books and seminars and so on.
     


Recent cases with taxpayers who screwed up their trader status one way of another (learn from their mistakes)

  • update: June 1, 2004.  Taxpayer went up against the IRS alone as a "pro se" in Tax Court.
    • 303 of the year's 323 transactions occurred in February through April, meaning only 20 transactions were made during the rest of the year.
    • Taxpayer was employed full-time as a computer chip engineer (and did not set his trading up within a separate entity) and therefore the trading was not the "sole or even primary activity in which the taxpayer engaged for the production of income."
    • Taxpayer failed to timely file a §475(f) M2M election before filing his tax return.
    • Taxpayer even failed to file his tax return on time.
    • Taxpayer filed his tax return only after it was already two years late and he was contacted by the IRS looking for $611,357 tax based on the gross amount of his sales of securities.
    • Taxpayer then filed an amended tax return with a "retroactive M2M election" seven weeks later.
    • The "retroactive M2M election" was prepared using "fractured English," rather than the more specific language required by the IRS Rev. Proc.

    See Frank Chen, TC Memo. 2004-132.  The IRS walked all over the taxpayer, though quite frankly the taxpayer had a weak argument that he was a trader rather than an investor and in any event, he was not entitled to use the M2M method of accounting.  He apparently filed his tax returns on his own, and he went up against the IRS and the Tax Court alone rather than with a trader status tax advisor and a lawyer familiar with the Tax Court procedures.


     

  • update: August 11, 2008.  Taxpayers using a husband-wife LLC lose mightily against IRS attack on their trader status.  Deemed to be investors rather than traders, the Court primarily looked to the evidence of the reported trading operations:
    • Their trading station, using a four computer monitor set-up, was in a dedicated room in their residence.  But the equipment was not reported on the LLC tax return.
    • M2M election was documented as being timely made on May 17, 2001 (probably on their internal books and records).
    • The brokerage accounts apparently were held in the bare legal title name of the individual with the individual's social security number (rather than held in the name of the LLC with the LLC's taxpayer ID#) and they were used by the individual, as his own, prior to the formation of the LLC.
    • 2001 - 289 trades were executed (no definition if a trade is a buy&sell or if a buy alone is a trade and a sell alone is a trade). Gross sales $754,277.  Margin interest of $7,660. They traded on 63 different days (40% of total possible days)
    • 2002 - 372 trades were executed.  Apparently there was zero margin interest. They traded on 110 different days (45% of total possible days)
    • Most positions were held open more than 31 days.  Very few were one-day flips.
    • Form 1040 was prepared using a (likely) pre-LLC trader status Schedule C (it is possible that this and other basic errors and oversights are what initiated the IRS inquiry to begin with).
    • Taxpayer was (probably) greedy and after losing $180,174 in 2001 from their LLC trading business, they took another $80,100 of additional trading "business expenses" on the Schedule C.
    • Continuing the (probable) greed in 2002 the taxpayer avoided the use of Schedule C, but took $34,294 of trading "business expenses" via the LLC on top of losing $11,227 from their trades.
    • The taxpayer's defense failed to show "that they sought to catch the swings in the daily market movements and to profit from these short-term changes."

    See G. Holsinger, TC Memo. 2008-191, Dec. 57,512(M).  The taxpayers apparently retained well-qualified estate planner   tax attorney's to represent themselves in this IRS controversy.  They also apparently retained a well-qualified estate planning attorney as the registered agent for the LLC.  But we have seen no indication that any tax professional having extensive experience with the unique characteristics of trader status was ever retained or consulted with by the taxpayers.


     

  • update: July 6, 2011.  Taxpayer defending himself as a "pro se" goes down in flames with $200,000 income taxes due, plus $40,000 in negligence penalties. Some of the facts in this case:
    • Taxpayer was earning his living from operating a ball bearing manufacturing and distribution business (rather than from trading).
    • M2M election was documented as being timely made in 1999.
    • Over three years taxpayer had only 313, 72 and 84 buys or sells.
    • Over three years taxpayer had activity (a buy or a sell) on only 29%  7% and 8% of the days that the stock market was open.
    • Over three years taxpayer had only 6, 4 and 3 same day trades.

    See Richard Kay Jr., TC Memo. 2011-159.  [alternative link]


     

  • update: August 28, 2013.  Taxpayer defending himself as a "pro se" loses it all - owes income taxes and penalties.
    • Taxpayer held too many common stock positions long-term, earning dividends and writing call options to reduce risk and enhance returns.
    • Heavy use of margin.
    • Over three years taxpayer had only 204 303 and 1,543 buys or sells.
    • Over three years taxpayer had activity (a buy or a sell) on 75,  99 and 112 days.
    • Over three years taxpayer had 10 months where he executed less than 4 trades.
    • Not only did the taxpayer fail to have a CPA and Lawyer involved in his representation, his home-brewed "research" was mostly limited to information gleaned from the IRS web site.
    • The taxpayer's "average holding period of 35 days demonstrates that he was not attempting to catch and profit from the swings in the daily market."

    See Thomas Endicott, TC Memo. 2013-199.

     



Taxpayers who qualify to file as Trader Status may optionally "elect" to do so simply by filing with the IRS a tax return reflecting this procedure for the "election" year, as described below and more fully in the a href="http://traderstatus.com/order.htm#TaxPlan">TradersTaxPlan, and then optionally "elect" again for each ensuing year.  Note: do not confuse "electing" TraderStatus with electing market-to-market.


This "election" treats what might otherwise be Schedule A "itemized deductions" as Schedule C "ordinary and necessary business expenses."   Generally a trader must make the "election" by filing a tax return or amended or superseding tax return that reflects this procedure (we suggest traders use certified mail with return-receipt-requested) with the IRS office where the trader normally mails his or her tax filings (1040, 1040X, 1065, 1120S, etc.) within the prescribed statute of limitation period.  That normally means within three years after the due date of the original tax return.  The IRS has seen tens of thousands of taxpayers who have made the decision to file this way since 2000.



Some other features of Trader Status are:   (see
Mark-to-Market Trader for different features)

  • Effective for years 2011 and thereafter, there is a  complicated reconciliation of IRS form 8949 and the broker issued form 1099-B that is required.
  • The year's net trading losses are "capital losses" and are therefore limited to the annual $3,000 "capital loss" limitation.  The year's net trading losses get added to any existing balance of your prior years' capital loss carryforwards.
  • The year's net trading gains are "capital gains" and are therefore offset against any old prior years' "capital loss" carryforwards.
  • The year's net trading gains, while part of a trade or business, are nonetheless not subject to Self-Employment tax under IRS Code §1402(a)(3)(A) as further clarified by IRS Code §1402(i) because they are taxed as "capital gains" (and they are of course subject to the capital gain 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 remaining after any offsetting capital loss carryforwards are usually taxed at the short-term (held less than twelve months) capital gains rate.  Additionally, it is possible that some securities, if inherited or if held in excess of twelve months, may be taxed at the lower long-term capital gains rate.
  • The year's net trading gains in §1256 contracts (futures) are usually taxed 40% at the short-term (held less than twelve months) capital gains rate and 60% at the long-term (held more than twelve months) capital gains rate.
  • The year's trading gains in each specific §988 transaction (FOREX) is usually taxed at your regular ordinary rates as interest income and net losses are deducted as interest expense.
  • Stocks are identified as either being subject to trader status or as held for investment.  Expenses associated with the investment securities are not subject to full deductibility as business expenses, but rather are itemized deductions subject to limitations.
  • The Wash Sales rules are applicable for these securities.
  • A wife may have a trader status business separate and apart from her husband's.
  • Any paper gains or losses on securities held overnight on December 31st are usually deferred until they are actually sold and are not shown on the current year's tax return.
  • Sole proprietors report expenses (which generally includes margin interest) on Schedule C and trading activity (which generally includes the commissions thereon) on Schedule D,  (see instructions page D-3 "Traders in Securities").
  • Sole proprietors may report each sale on an IRS Schedule D-1.  IRS may restrict the old "see statement attached" along with summary totals, effective with the 2005 form 1040.  Also there's no allowable "details provided upon request" either (see instructions page D-6).
  • 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.


A securities trader is someone engaged primarily in speculative activity from which he or she derives most of his or her income, seeking to profit from short-term market swings. (Liang v. Comr.)

A trader will not be looking for interest income or dividends from the stocks he buys. The stocks held by a trader are usually characterized by high price volatility rather than a dividend yield or long-term growth potential.

But what if an individual is not primarily engaged as a trader?  In other words, what if trading, while very active, is only a part-time or seasonal activity?  What if the individual has full employment elsewhere?  What if the individual has significant interest income or dividends from non-trading investments?  There's still an answer!  Look into A Trader's Choice of Entities.

Strange as it may seem, the IRS Code does not define who or what a securities trader is (but starting in 2000 the IRS form 1040 instructions do). To further guide us there are a number of Tax Court decisions which decided whether a taxpayer's transactions in securities constituted a bona-fide trade or business.  Among the most important court decisions were those regarding whether a full-time professional gambler's wagering activity constituted a trade or business for income tax purposes. (Groetzinger v. Comr. 1985) "there is an equitable basis for according a high-volume short-term trader different tax treatment than the taxpayer who occasionally engages in a short-term trade."

In (Comr. v Groetzinger 1987), the Supreme Court concluded "to be engaged in a trade or business, the taxpayer must be involved in the activity with continuity and regularity and that the taxpayer's primary purpose in engaging in the activity must be for income or profit." This landmark decision confirmed the availability of trader status for income tax purposes. (IRS Code §162(a) and §62(a)(1)).

Example:  An individual's trader status was approved where his entire income was derived from his securities trading (a good argument for setting up your own
pure-play trading entity), he devoted his whole working day to his stock transactions (having W-2 wage employment is not helpful here, again an argument for establishing an entity),  and judgments regarding purchases and sales were made directly by him, based on his personal investigation of the assets, operation, and management of various corporations. In addition, the sheer quantity of transactions he conducted supported a reasonable conclusion that his business was trading on his own account. In the year in question, he conducted 332 transactions representing the transfer of 112,400 shares with a total value of over $3,000,000. Furthermore, it was his practice to buy to the maximum extent of allowable margin. (Levin, Samuel)

To substantiate your stock, option and futures trading activity, it is a good idea each day for some traders to print out their activity, including the unexecuted limit orders. This can then be given to IRS in the case of an audit.  These print-outs will show more activity than mere executed orders that are reported on Schedule D, form 6781 and  form 4797.

Definition of a Securities Trader

The Taxpayer Relief Act of 1997 summarized that "traders  in securities generally are taxpayers who engage in a trade or business involving active sales or exchanges of securities on the market. rather than to customers."

The IRS FAQ site has said that:  "Investors  trade solely for their own account and do not carry on a trade or business. Their securities sales result in capital gain or loss and their deductible expenses are itemized deductions. Dealers  sell securities to customers in the ordinary course of trade or business. Their sales result in ordinary gain or loss and their deductible expenses are trade or business expenses. Traders  buy and sell securities frequently but have no customers. Their purchases and sales result in capital gain and loss, and their deductible expenses are trade or business expenses."

"Even if you engage in extensive securities activities, you are an investor, not a dealer or trader, if you do not seek profit primarily in swings in daily market movements, and do not personally engage in or direct the purchases or sales. An investor trades for profit-motivated reasons such as long-term appreciation, dividends and interest. Whether the activities of an individual constitute trade or business or investment is determined from the facts in each case. These distinctions have been established through court cases."


Definition of a Securities Trader - Tax Court

"...in order to qualify as a Schedule C trader in securities, a taxpayer is generally required to rely on trading activity as a primary source of income and meet meticulous recordkeeping standards."

"Petitioner did not qualify as a Schedule C trader in securities because he had substantial Form W-2 income for some of the years in issue and failed to present any of the required mark-to-market accounting."

T.C. Memo. 2009-11
EDWARD R. VOCCOLA, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent



What the Court thought of a tax advisor's recommendation to retroactively prepare a partnership tax return with a so-called "internal" M2M election:

"The Form 1065 was signed by petitioner's accountant ...  At the conference petitioner claimed that as partners he and his wife made an 'internal' election in 2000 to use the mark-to-market method of accounting."

"We disagree.  ..petitioner’s Form 1065 was never filed with respondent, was not signed by petitioner and his wife, and was not submitted to respondent’s counsel until over 5 years after it was due. Additionally, petitioner did not attach to petitioners’ tax returns for 2000, 2001, or for any other year, a statement making the mark-to-market election, identifying the first taxable year for which the election was to be effective, and describing the business to which the election was to relate. Courts have consistently held that a securities trader did not make an election under section 475 where the trader did not follow the election requirements of Rev. Proc. 99-17, supra."

T.C. Memo. 2008-297
MARK N. KANTOR AND MARLA R. KANTOR, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
 

 What a typical Trader in Securities looks like (per the Courts):

  • A trader purchases and sells securities frequently to catch the daily market movements and to profit on a short-term basis. (C.H. Liang v Commr)
  • A trader's profits are derived through direct management of purchasing and selling. (R.E. Purvis v Commr)
  • A trader does not perform merchandising functions or any services that need be compensated, and does not have any customers. (G.R. Kemon v Commr)
  • A trader engages in a continuous volume and magnitude of purchases and sales. (J.M. Ferguson, Sr. v Commr)
  • The amount of time spent on trading is important to trader status. (Chemical Bank & Trust Co. v US)
  • A trader's activities are directed to short-term trading, not the long-term holding of investments, and income principally is derived from the sale of securities rather than from dividends and interest paid on those securities. Relevant considerations in determining whether a taxpayer is a trader or investor are the taxpayer's investment intent, the nature of the income to be derived from the activity, and the frequency, extent, and regularity of the taxpayer's securities transactions. (R.E. Purvis v Commr)
  • Consider the subjectivity of what in particular is meant by the frequency, extent and regularity of transactions that identify the person entering into them as a trader rather than an investor.
  • A trader engages in transactions almost daily for a continuous period that exceeds a single tax year. (F.Chen v Commr)
  • Traders ordinarily engage in trading activity as a sole or primary source of income. (F.Chen v Commr)
     

Definition of a Securities Trader

The 2000 to 2011 instructions for form 1040, Schedule D state:  "To be engaged in business as a trader in securities:
  • 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.
  • 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 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.
  • The amount of time you devote to the activity."


Definition of a Securities Trader per proposed REG-130507-11 December 5, 2012

(C)(i) Distinguishing between dealers, traders, and investors

Determining whether trading in financial instruments or commodities rises to the level of a section 162 trade or business is a question of fact. Higgins v. Comm'r, 312 U.S. 212, 217 (1941); Estate of Yaeger v. Comm'r, 889 F.2nd 29,33 (2nd Cir. 1989). In general, section 475(c)(1) provides that the term dealer in securities means a taxpayer who (A) regularly purchases securities from or sell securities to customers in the ordinary course of a trade or business, of (B) regularly offers to enter into, assume, offset, assign, or otherwise terminate positions in securities with customers in the ordinary course of a trade or business. In contrast, a trader seeks profit from short-term market swings and receives income principally from selling on an exchange rather than from dividends, interest, or long-term appreciation. Groetzinger v. Comm'r, 771 F,2nd 269,274-275 (7th Cir. 1985), aff'd 480 U.S. 23 (1978); Moller v. United States, 721 F.2nd 810, 813 (Fed. Cir. 1983). A person will be a trader, and therefore engaged in a section 162 trade or business, if his or her trading is frequent and substantial, which has been rephrased as "frequent, regular, and continuous." Boatner v. Comm'r T.C. Memo. 1997-379, aff'd in unpublished opinion 164 F.3d 629 (9th Cir. 1998).

An Investor is a person who purchases and sells securities with the principal purpose of realizing investment income in the form of interest, dividends, and gains from appreciation in value over a relatively long period of time (that is long-term appreciation). The management of one's own investments is not considered a section 162 trade or business no matter how extensive or substantial the investments might be.  See Higgins v. Comm'r, 312 U.S. 212, 217 (1941); King v. Comm'r, 89 T.C. 445 (1987). Therefore, as investor is not considered to be engaged in a section 162 trade or business of investing.

For purposes of section 1411(c)(2)(B), in order to determine whether gross income is derived from a section 162 trade or business of trading in financial instruments or commodities, the gross income must be derived from an activity that would constitute trading for purposes of chapter 1. Therefore, a person that is a trader in commodities or a trader in financial instruments is engaged in a trade or business for purposes of section 1411(c)(2)(B). The Treasury De
ment and the IRS emphasize that the proposed regulations do not change the state of the law with respect to classification of traders, dealers, or investors for purposes of chapter 1.


Definition of a Part-Time Trader

The Internal Revenue Service recently took a quasi-position regarding "part-time traders" which is discussed at this link: Part-time traders and other special situations.  Part-time traders should strongly consider forming a separate entity to trade through to avoid, as much as possible, negative IRS issues.


Definition of a business determined from per IRS Summertime Tax Tip 2009-18:

Here are eight questions that will help determine if your activity is a business:
  1. Is the purpose of your activity to make a profit? Generally, your activity is considered a business if it is carried on with the reasonable expectation of earning a profit.
  2. Do you participate in your activity just for fun? Playing the market for enjoyment of it and not pursued for significant profit.
  3. Do you depend on income from the activity? If so, your activity is likely considered a business.
  4. Have you changed methods of operation to improve profitability? If so, your activity may actually be a business.
  5. Do you have the knowledge needed to carry on the activity as a successful business? People who carry out the activity without obtaining the training, books and studies often don't have the business acumen to turn their not-for-profit activity into a profitable business venture.
  6. Have you made a profit in similar activities in the past? This may indicate your activity is a business rather than not-for-profit. An activity is presumed carried on for profit if it makes a profit in at least three of the last five tax years, including the current year - or at least two of the last seven years for activities that consist primarily of breeding, showing, training or racing horses.
  7. Does the activity make a profit in some years? Even if your activity does not make a profit every year, it still may be considered a business.
  8. Do you expect to make a profit in the future from the appreciation of assets used in the activity? This indicates your activity may be a business rather than a hobby.  MY COMMENT:  Though tax court cases have differed from this IRS position when it comes to the business of a "securities trader."

 

Definition of a Securities Trader from IRS Auditors' guide book:
What Is a Securities Trader?

"Although the Supreme Court has yet to find a taxpayer properly characterized as a 'securities trader,' it is clear that such a 'businessman' exists, given the proper facts."  (Levin v. United States, 79-1 U.S.T.C. 9331)   The standard applied by the lower courts to distinguish between an investor and a trader was first enunciated by the Tax Court in Liang v. Commissioner (23 T.C. 1040):  "In the former, securities are purchased to be held for capital appreciation and income, usually without regard to short-term developments that would influence the price of securities on the daily market.  In a trading account, securities are bought and sold with reasonable frequency in an endeavor to catch the swings in the daily market movements and profit thereby on a short-term basis.  There is general agreement amongst the courts (Moeller v. United States, 83-2 U.S.T.C. 9698 and Purvis v. Commissioner, 76-1 U.S.T.C. 9270) that the following factors are to be considered in determining whether a taxpayer is an investor or engaged in the trade or business of securities trading:

  1. The taxpayer's intent- investment negates trader status.
  2. Nature of the income from the activity- only short term gains qualify as trading income.
  3. Frequency, extent and regularity of transaction- holding period can be critical.

Items 2 and 3 are objective (and quantitative) indicators of intent which are principally relied on.  Taxpayers who mention "capital appreciation" or even "conservation of capital" do not prevail.  Significant long term capital gains, and even dividends and interest, are strong indications of an investor and not a trader.

In one instance, the Court of Claims (Mayer v. United States, 94-2 U.S.T.C. 50,509) took the position that a taxpayer who carefully selected money managers and farmed out a portion of his funds to each could not be considered a securities trader since he did not actually make any purchase or sale decisions himself; - To claim a trade or business deduction, taxpayer must himself perform the activity characterizing the 'trade or business' citing Groetzinger (87-1 U.S.T.C. 9191).  The Tax Court considered the same taxpayer for subsequent years and came to the same result based on holding period and frequency of trading.  (Mayer v. Commissioner, TCM 1994-209)

The Supreme Court provided in Higgins that expenses related to real estate rental were deductible and that office and salary expenses could reasonably be allocated between investment and trade or business.  Accordingly, even where it has been determined that a partnership is engaged in the trade or business of securities trading, care must taken to ensure that any portion of the partnership's activity or expenses that are properly allocable to investment should be separately stated.

http://www.irs.gov/businesses/partnerships/article/0,,id=134701,00.html#5


Typical
analysis made during an IRS examination (form 886A):

The Internal Revenue Code does not define the term "trade or business" for purposes of I.R.C. §162.  Whether activities constitute a trade or business is a question of fact.

In determining whether a taxpayer is a trader, nonexclusive factors to consider are:

  1. the taxpayer's intent,
  2. the nature of the income to be derived from the activity, and
  3. the frequency, extent and regularity of the taxpayer's securities transactions. (Moller v. United States, 721 F.2d 810,813 (Fed.Cir.1983))

For a taxpayer to be a trader the trading activity must be substantial, which means "frequent, regular and continuous enough to constitute a trade or business" as opposed to sporadic trading. (Ball v. Comr, T.C. Memo 2000-245 {quoting Hart c. Comr, T.C. Memo 1997-11})  A taxpayer's activities constitute a trade or business where both of the following requirements are met:

  1. the taxpayer's trading is substantial, and
  2. the taxpayer seeks to catch the swings in the daily market movements and to profit from these short-term changes rather than to profit from the long-term holdings of investments. (Mayer c. Comr, T.C. Memo 1994-209)

 

IRC Sec. 469. Passive Activity Rules show consistency in the requirements for regular, continuous and substantial.

  • §469(h) Material Participation Defined
    For purposes of this section--
    §469(h)(1) In General
    A taxpayer shall be treated as materially participating in an activity only if the taxpayer is involved in the operations of the activity on a basis which is--
  • §469(h)(1)(A) regular,
  • §469(h)(1)(B) continuous, and
  • §469(h)(1)(C) substantial.


IRS ATG on Passive Activity Losses

There are two major exceptions to the passive loss rules:

  1. Working interests in oil and gas activities; [IRC § 469(c)(3), Reg. § 1.469-1T(e)(4)(v)] and,
  2. Traders in stocks and bonds [Reg. § 1.469-1T(e)(6) ].


Publicly Traded Partnerships (PTP) have a special Passive Activity Rule:

Income from commodities and commodity futures, forwards, and options with respect to commodities (including options) if the partnership's principal activity is buying and selling commodities are considered passive activity income for PTP's §7704(d)(1).

The IRS issued final regulations under Regs. §1.7704-3, which generally expanded the types of qualifying income to include certain investment income such as capital gain from the sale of stock, income from holding annuities, income from national principal contracts (as defined in Regs. §1.446-3), and other substantially similar income from ordinary and routine investments to the extent determined by the IRS.

However, under Regs. §1.7704-3(a)(2), qualifying income does not include income derived in the ordinary course of a trade or business. Regs. §1.7704-3(b)(2) clarifies that gain recognized with respect to a marked to market position will not fail to be qualifying income solely because there is no sale or disposition. Regs. §1.7704-3(b)(3) also clarifies that certain ordinary income may be qualifying income. Regs. §1.7704-3(b)(4) provides rules for computing qualifying and gross income of a partnership that makes a mixed straddle account election under Regs. §1.1092(b)-4T. Also, Regs. §1.7704-3(b)(1) clarifies that, in general, all losses will be ignored in determining partnership gross income for purposes of §7704(c)(2).

 

Definition of a Commodities Trader

§1258(d)(5)(B) Definitions. --
For purposes of this paragraph --
1258(d)(5)(B)(i) Options Dealer. --
The term 'options dealer' has the meaning given such term by section 1256(g)(8).

1258(d)(5)(B)(ii) Commodities Trader. --
The term 'commodities trader' means any person who is a member (or, except as otherwise provided in regulations, is entitled to trade as a member) of a domestic board of trade which is designated as a contract market by the Commodity Futures Trading Commission.

 

1256(g)(8) Options Dealer
1256(g)(8)(A) In General
The term "options dealer" means any person registered with an appropriate national securities exchange as a market maker or specialist in listed options.

1256(g)(8)(B) Persons Trading In Other Markets
In any case in which the Secretary makes a determination under subparagraph (C) of paragraph (7), the term "options dealer" also includes any person whom the Secretary determines performs functions similar to the persons described in subparagraph (A). Such determinations shall be made to the extent appropriate to carry out the purposes of this section.


Definition of Commodities-Futures Dealers (Traders) from H.R. Conf. Rep. No. 106-1033, at 1036 (2000):

The determination of who is a dealer in securities futures contracts is to be made in a manner that is appropriate to carry out the purposes of the provision, which generally is to provide comparable tax treatment between dealers in securities futures contracts, on the one hand, and dealers in equity options, on the other. Although traders in securities futures contracts (and options on such contracts) may not have the same market-making obligations as market makers or specialists in equity options, many traders are expected to perform analogous functions to such market makers or specialists by providing market liquidity for securities futures contracts (and options) even in the absence of a legal obligation to do so. Accordingly, the absence of market-making obligations is not inconsistent with a determination that a class of traders are dealers in securities futures contracts (and options), if the relevant factors, including providing market liquidity for such contracts (and options), indicate that the market functions of the traders is comparable to that of equity options dealers.  Internal Revenue Bulletin:  2004-38 


Definition of a Trader from the preamble to proposed Reg. 1.1411

A person will be a trader, and therefore engaged in a section 162 trade or business, if his or her trading is frequent and substantial, which has been rephrased as "frequent, regular, and continuous." Boatner v. Comm'r, T.C. Memo. 1997-379, aff'd in unpublished opinion 164 F.3d 629 (9th Cir. 1998).

Further, the text in proposed Reg. 1.1411-9 implies that a reasonable level of trader expenses is in the range of 25% to 37.5% of the amount of the net gain from the year's trading.

 


IRS web site Tax Topic 429
http://www.irs.gov/taxtopics/tc429.html
Additions/Deletions/2011Additions/
2013 Additions/2014 Additions over the years are indicated by the colored edits inserted below

Topic 429 - Traders in Securities (Information for Form 1040 Filers)

This tax topic explains whether an individual who buys and sells securities qualifies as a "trader in securities," for tax purposes and how traders must report the income and expenses resulting from the trading business. In order to better understand the special rules that apply to traders in securities, it is helpful to first review the meaning of the terms: "security," "investor," "dealer," and "trader," and the different manner in which investors they report the income and expenses relating to their investment activities. Internal Revenue Code Section 1236 defines "security" as any share of stock in any corporation, certificate of stock or interest in any corporation, note, bond, debenture, or evidence of indebtedness, or any evidence of an interest in or right to subscribe to or purchase any of the foregoing.

Comment: The previous paragraph was modified on the IRS web site in January 2013.  Just prior to that, the proposed IRS Regulation 1.1411-5 made reference to "trading in financial instruments or commodities."  We feel that it would be helpful for the IRS website to address these terms as well as the terms listed above.

Investors

"Investors" typically buy and sell securities and expect income from dividends, interest, or capital appreciation. They buy and sell these items and hold them for personal investment; they are not conducting a trade or business. **Most investors are individuals.**  Sales of these securities result in capital gains and losses that must be reported on Form 1040, Schedule D (PDF), Capital Gains and Losses and on Form 8949 (PDF), Sales and Other Dispositions of Capital Assets, as appropriate. Investors are subject to the capital loss limitations described in section 1211(b), in addition to the section 1091 wash sales rules. Investors can generally deduct may be able to benefit from a deduction for the expenses of producing taxable investment income. These include expenses for investment counseling and advice, legal and accounting fees, and investment newsletters. These expenses are deductible reported on Form 1040, Schedule A (PDF). (PDF), Itemized Deductions, as miscellaneous deductions to the extent that they exceed 2% of adjusted gross income. Interest paid on money to buy or carry investment property that produces taxable income is also deductible on Schedule A, but under section 163(d) the deduction cannot exceed the net investment income. 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. Review Topic 703 , Basis of Assets for additional information. An investor is not subject to self-employment tax. For more information on investors, refer to Publication 550, Investment Income and Expenses.

Dealers

"Dealers" in securities **may be individuals or business entities.** Dealers purchase, and hold securities, and sell securities to their customers in the ordinary course of their trade or business; sometimes they maintain an inventory. Dealers are distinguished from investors and traders because they have customers, derive their income from marketing securities for sale to customers., and may charge their clients fees for services rendered. Because they are in the trade or business of buying and selling, the gains and losses of dealers are classified per section 1236 as ordinary gains and losses. Section 1236 also requires that dealers must keep and maintain records that clearly identify securities held for personal gain versus those held for use in their business activity. Dealers who are individuals must report their expenses on Form 1040, Schedule C (PDF). They report the income in excess of their trading activities on Schedule C as well; however, they report gains and losses associated with dispositions of securities by using the mark-to-market rules discussed further below.

Traders

Special rules apply if you are a trader in securities, in the business of buying and selling securities for your own account. **Note that unlike the new 2013 text in the paragraphs above, the IRS is silent here as to whether a trader in securities is usually an individual, or a business entity.** This is considered a business, even though you do not maintain an inventory and do not have clients customers. 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 does 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," you are an investor.  Further, As with dealers, a A taxpayer may be a trader in some securities and may 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 (for example, by holding them in a separate brokerage account).

Traders report their business expenses on Form 1040, Schedule C (PDF), Profit or Loss From Business. The limit Schedule A   limitations on investment interest expense, which applyies 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. See Topic 703, Basis of Assets (deleted early 2013 but put back in in 2014>Gains and losses from selling securities from being a trader as part of a trading business are not subject to self-employment tax. <deleted early 2013 but put back in in 2014) (deleted early 2014>Dividends, interest from securities, and gain or loss from the sale of capital assets are not considered proceeds from self-employment income unless received by a dealer in stocks and securities in the course of their business. Review the Form 1040, Schedule SE Instructions, Self-Employment Tax.

(the early 2014 version of the above paragraph is repeated/shown below without the clutter of the changes)

Traders report their business expenses on Form 1040, Schedule C (PDF), Profit or Loss From Business. The Schedule A limitations on investment interest expense, which apply to investors, do 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. See Topic 703, Basis of Assets. Gains and losses from selling securities from being a trader are not subject to self-employment tax.

The Mark-to-Market Election

(deleted early 2014>In addition to the deduction of their business expenses on Schedule C, <deleted early 2014) traders are entitled to an (deleted early 2014>additional<deleted early 2014) option not extended to investors:, the usage of the mark-to-market rules election. To explain, the tax treatment of sales of securities held in connection with a trading business depends on whether a trader has previously made an election under section 475(f) to use the mark-to-market method of accounting. If the mark-to-market election was not made, then the gains and losses from sales of securities are treated as capital gains and losses that must be reported on Form 1040, Schedule D (PDF). The $3,000 limitation When reporting on Schedule D, bBoth the limitations on capital losses and the wash sale rules continue to apply. However, if the mark-to-market election was timely made, then the gains and losses from sales of securities are treated as ordinary gains and losses (except for securities held for investment - see above) that must be reported on Part II of Form 4797 (PDF), Sales of Business Property. Further, neither the limitations on capital losses nor the wash sale rules apply to traders using the mark-to-market method of accounting.

(deleted early 2014>The Mark-to-Market Election<deleted early 2014)

In general, the mark-to-market election must be made by the due date (not including extensions) of the tax return for the year prior to the year for which the election becomes effective. To make the mark-to-market election for 2004, you must file a statement by April 15, 2004. This statement should be attached to either your 2003 individual income tax return or to a request for an extension of time to file that return. To make the mark-to-market election for 2005, you must file a statement by April 15, 2005. This statement should be attached to either your 2004 individual income tax return or to a request for an extension of time to file that return.The election is made by attaching a statement either to your income tax return or to a request for an extension of time to file your return. [Comment: After at least three revisions, the IRS verbiage in this last sentence still causes dangerous confusion for taxpayers.  My suggestion is: "If you are a trader in securities, who is operating as a sole proprietorship, the election is made by attaching a statement to your timely filed individual income tax return, form 1040 (filed timely without the need for a request for an extension of time to file); or by attaching a statement to your timely filed request for an extension of time to file, form 4868."] The statement should include the following information:

  1. That you are making an election under section 475(f) of the Internal Revenue Code;
  2. The first tax year for which the election is effective; and
  3. The trade or business for which you are making the election.

[ong>Comment: While the IRS' header here clearly states that this text pertains to "Traders in Securities (Information for Form 1040 Filers)" it wouldn't have hurt to point out that the rules for "Traders in Commodities" (which includes Futures trading) is a separate election.  Most taxpayer and their tax advisors are unaware of this fact. Also when there are multiple taxpayers/entities involved, most taxpayer and their tax advisors are not aware of which taxpayer/entity makes the election in order for it to be valid and binding.  And also that "Traders in FOREX" (Foreign Exchange)  have yet a completely different system of tax elections.]

Refer to the Form 1040, Schedule D Instructions, Capital Gains and Losses, for for further instructions on how to make the mark to market election.

After making the election to change to the mark-to-market method of accounting, you must change your method of accounting for securities under Revenue Procedure 2002-9, as modified by Revenue Procedures 2002-19.  (deleted mid 2013> 2008-52, 2009-39 and <deleted mid 2013) 2011-14. In addition to making the election, you will also be required to file a Form 3115 (PDF), Application for Change in Accounting Method. The procedures for making an election are described in Publication 550 under the section called "Special Rules for Traders in Securities",   You may also refer to Revenue Procedure 90-17. and FAQs on our Web site.  

Comment: The following green paragraph was recently added to the IRS web site, apparently as their attempt to circumvent a a long-standing position of TraderStatus.com that a taxpayer who is changing his method of accounting to M2M must timely file both the election statement (in advance) and the form 3115 one year later.  With the obvious loophole being that a taxpayer could file a protective advance election statement (year-after-year if desired) and then using hindsight either perfect that year's election by filing form 3115, or purposefully fail to file form 3115 and thereby cancel out their protective election statement.

Rev. Proc. 99-17 Sec 6.02(2) required that the taxpayer "must complete and file a Form 3115" in order to change the taxpayer's accounting method.
Rev. Proc. 99-49 Sec 6.02(2) required "Timely duplicate filing" of form 3115 in order to change the taxpayer's accounting method.
Rev. Proc. 2002-9 Sec 6.02(3) required "Timely duplicate filing" of form 3115 in order to change the taxpayer's accounting method.
Rev. Proc. 2002-19 Sec 4.04(1)(c) required that the taxpayer "must complete and file a revised Form 3115 in duplicate".
Rev. Proc. 2008-52 Sec 6.02(3) requires "Timely duplicate filing" of form 3115 in order to change the taxpayer's accounting method.
Rev. Proc. 2009-39 may require sending a third "Additional copy of Form 3115" to: IRS, 1973 North Rulon White Blvd., Mail Stop 4917, Ogden, UT 84404.
Rev. Proc. 2011-14
Sec 6.02(3)(a)(ii)(B) clarifies that the Ogden copy is in lieu of the duplicate national office copy.

How the Courts will decide this odd complication is yet to be seen.  Particularly the IRS's catch 22's (1) saying that not filing a Form 3115 will not invalidate a "valid election" when, by definition, the taxpayer does not have a "valid election" unless From 3115 is filed and  (2) saying that a "second Form 3115" must be filed to revoke the election statement, rather than the taxpayer merely neglecting to timely file the initial Form 3115.  Which then begs the question how can a taxpayer timely file a "second" Form 3115 when no "first" Form 3115 was (timely) filed to begin with?   By definition, Form 3115 must be timely filed to be effective, therefore after a period of time, there can never be a "first" valid From 3115 filed to allow for a "second" Form 3115 to be filed to revoke the M2M election.  Perhaps this means that the IRS's position for now is that the M2M election then must follow the taxpayer to his grave.

If you have made a valid election under section 475(f), the only way to stop using mark-to-market accounting for securities is to request and receive written permission from the Service to revoke the election. Non-filing of the Form 3115 mentioned above will not invalidate a timely and valid election. To request permission to revoke your election under section 475(f), you must file a second Form 3115 and pay a fee. ($625 or $2,500)

Above IRS Tax Topic was Last Reviewed or Updated: March 04, 2010
and Page Last Reviewed or Updated: February 07, 2011
and Page Last Reviewed or Updated: March 01, 2011
and Page Last Reviewed or Updated: September 23, 2011
(no changes were made between February 7, 2011 and September 23, 2011)

and Page Last Reviewed or Updated: December 22, 2011
and
Page Last Reviewed or Updated: August 11, 2012
(no changes were made between December 22, 2011 and August 11, 2012)
and Page Last Reviewed or Updated: November 7, 2012)
(no changes were made between
August 11, 2012 and November 7, 2012)
and Page Last Reviewed or Updated: January 04, 2013
and Page Last Reviewed or Updated: April 01, 2013
and Page Last Reviewed or Updated: February 27, 2014

 

SECTION 23. MARK-TO-MARKET ACCOUNTING METHOD FOR DEALERS IN SECURITIES (§ 475)

.01 Commodities dealers, securities traders, and commodities traders electing to use the mark-to-market method of accounting under § 475(e) or (f).

(1) Description of change. This change applies to certain taxpayers that have elected to use the mark-to-market method of accounting under § 475(e) or (f). Under § 475(e) and (f) and Rev. Proc. 99-17, 1999-1 C.B. 503, if a taxpayer makes an election under § 475(e) or (f), then beginning with the first taxable year for which the election is effective (election year), mark to market is the only permissible method of accounting for securities or commodities subject to the election. Thus, if the electing taxpayer’s method of accounting for its taxable year immediately preceding the election year is inconsistent with § 475, the taxpayer is required to change its method of accounting to comply with the election. A taxpayer that makes a § 475(e) or (f) election but fails to change its method of accounting to comply with that election is using an impermissible method. See section 4 of Rev. Proc. 99-17.

(2) Scope. This change applies to a taxpayer if all of the following conditions are satisfied:

(a) the taxpayer is a commodities dealer, securities trader, or commodities trader that has made a valid election under § 475(e) or (f) (see section 5.03(1) of Rev. Proc. 99-17) and that is required to change its method of accounting to comply with the election;

(b) the method of accounting to which the taxpayer changes is in accordance with its election under § 475(e) or (f); and

(c) the year of change is the election year.

(3) Scope limitations inapplicable. The scope limitations in section 4.02 of this revenue procedure do not apply to this change.

(4) Election under Rev. Proc. 99-17. In accordance with section 5.03(1) of Rev. Proc. 99-17, in order to make a section 475(e) or (f) election, a taxpayer must file a statement satisfying the requirements in section 5.04 of Rev. Proc. 99-17. The statement must be filed not later than the due date (without regard to extensions) of the original federal income tax return for the taxable year immediately preceding the election year and must be attached either to that return or, if applicable, to a request for an extension of time to file that return. For example, if a calendar year individual taxpayer wants to make a section 475(e) or (f) election for 2009 (the election year), the taxpayer must file the statement on or before April 15, 2009, with the taxpayer’s timely filed (without regard to extensions) federal income tax return for 2008 or the taxpayer’s timely filed request for an extension of time to file the 2008 federal income tax return. On the Form 3115 filed for the year of change, a taxpayer should indicate that the taxpayer has filed the statement in compliance with section 5.03(1) of Rev. Proc. 99-17.

(5) Designated automatic accounting method change number. The designated automatic accounting method change number for a change under section 23.01 of this APPENDIX is "64." See section 6.02(4) of this revenue procedure.

(6) Contact information. For further information regarding a change under this section, contact Eric E. Boody at 202-622-3950 (not a toll-free call).

.02 Reserved.

http://www.irs.gov/irb/2011-04_IRB/ar08.html#d0e9496

 




Trader Deductions
An individual trader's expenses relating to his trade or business are usually fully deductible under IRS Code §162 as "above the line" items. Thus, unlike an investor, most of an individual trader's expenses (within reason) are deducted on Schedule C rather than as itemized expenses on Schedule A.

The expenses are deductible only if they are ordinary and necessary expenses and they are directly connected with or pertain to the trade or business.   An expense is "ordinary" if it is customary or accepted in the taxpayer's business.  A "necessary" expense is appropriate and helpful to the business; it doesn't have to be indispensable or essential.  Adequate records documenting your expenses should be maintained.

These expenses can include but are in no way limited to:

  • tax advice including, for example, fees paid to TraderStatus.com
  • trading counsel
  • subscriptions to financial magazines and newspapers
  • trader guides and books
  • custodial fees
  • seminars and ongoing education (if not merely qualifying an investor to become a trader)
  • Most start-up and early organization expenses incurred after October 22, 2004 for an entity are fully deductible, rather then being amortized over 60 months as the earlier rule required.  The deduction is claimed for the year the business starts, and not the year the payments are made (if made in an earlier year)
    • start-up and organizational costs (paid after 10/22/04)
      • up to $5,000 maximum is deducible in the first year (through 2009)
      • up to $10,000 maximum is deducible in the first year (starting 1/1/2010)
      • any amount over $5,000/$10,000 generally must be amortized over 15 years
      • election is only allowed if tax return is not filed late
      • for items paid or incurred after 10/2204 and before 9/9/08  the irrevocable default is to capitalize them
      • for items paid or incurred after 9/8/08 the irrevocable default is to expense them
  • dedicated telephone usage and long distance
  • cell phone, pager and messenger fees
  •  wireless trading fees
  • cable fees
  • on-line services and connection fees
  • real-time quotes, charting and analysis
  • stock tip services & newsletters and news service fees
  • trader chat room fees or subscriptions
  • office rent (but not if paid to yourself)
  • office supplies, postage, bank charges and wire fees
  • certain club memberships, dues and fees
  • clerical and record keeping expenses
  • prepayments that do not extend beyond 12 months are deductible when paid, except these have some limitations:
    • prepaid interest
    • prepaid rent
    • prepaid leases
    • prepaid taxes
  • wages paid to your spouse, kids, or parents for their assistance
  • deductible retirement plans, including the Single-Participant 401k on those wages (click here for more) (if the business is properly designed)
  • a non-deductible Roth IRA in lieu of a regularly deductible IRA
     
  • interest expense paid:
    • on loans used for the purchase of the trader's positions
    • including, in certain circumstances, your credit card interest under the §1.163-8T general tracing rules
    • on home mortgage debt if an irrevocable §1.163-10T(o)(5) election is made
    • this so-called "margin interest" is generally fully deductible for active traders because it is not subject to the regular "investment interest" limitation on IRS form 4952
    • passive investors in trading entities are subject to the §163(d)(1) limitation (as typically shown on IRS form 4952)  update: IRS Rev Rul 2008-12 has officially agreed with this position.  Further, IRS Announcement 2008-65 and IRS Rev Rul 2008-38 state that the allowable interest (typically from IRS form 4952) is deductible on Schedule E, rather than on Schedule A as was the previously held IRS position.

  • depreciation on furniture, television, computer equipment and software.
    • computers & equipment 5 year life (Rev Proc 87-56)
    • office furniture & fixtures 7 year life (Rev Proc 87-56)
    • it is penny wise and pound "audit bait" foolish (or just plain ignorance) taking a deduction using other periods such as 3 year lives (which by law is basically limited to tractors and horses ( §168(e)(3))
      • the 50% bonus depreciation rule expired on 12/31/2004
      • a new 50% bonus depreciation rule is effective 1/1/2008 through 9/8/2010 for many new (not used) items of personal property.  Many passenger vehicles can get as much as approximately $11,000 first year depreciation.
      • a new 100% bonus depreciation rule is effective 9/9/2010 through 12/31/2012 for many new (not used) items of personal property.
      • a new 50% bonus depreciation rule is effective 1/1/2012 through 12/31/2012 for many new (not used) items of personal property.
    • Depreciation Limits for Passenger Cars
       
  • up to $128,000 $250,000 of "§179 deduction" in 2008 ($102.,000 in 2004, $105,000 in 2005 and $108,000 in 2006 and retroactively modified from the original $112,000 to $125,000 for 2007) in lieu of depreciation (if proper election is filed)
    • computers, other equipment, software and furniture qualify.
    • automobiles and SUV's on a car chassis with unloaded GVW of 6,000 pounds and SUV's on a truck chassis , Trucks & Vans with a loaded GVW over 6,000 pounds may be eligible for §179 (through 10/22/2004)
    • Effective 10/23/2004 SUV's weighing 6,001 to 14,000 pounds may be eligible for §179 to a maximum of $25,000.  SUV's over 14,000 pounds or holding a driver + 9 passengers still have the $112,000 limitation.
    • Effective 1/1/2008 SUV's weighing 6,001 to 14,000 pounds as proposed may NOT be eligible for §179. First year depreciation would be limited to $2,960.
    • $108,000 limit (as adjusted for inflation) was scheduled to revert to $25,000 on January 1, 2006 (on 10/22/04 this provision was extended to January 1, 2008)
    • to qualify for the annual $250,000  §179 deduction you must spend less than $510,000 $800,000 in 2008 ($410,000 in 2004 and $420,000 in 2005 and $430,000 in 2006 and $500,000 in 2007)
  • travel and automobile expense
  • auto mileage rate 2014 up to four cars at a time @ 56¢/mile (depreciation portion is 22¢)
    • note that the medical & moving mileage rates are 23.5¢/mile
    • the charitable purposes mileage rate is 14¢/mile
  • auto mileage rate 2013 up to four cars at a time @ 56.5¢/mile (depreciation portion is 23¢)
    • note that the medical & moving mileage rates are 24¢/mile
    • the charitable purposes mileage rate is 14¢/mile
  • auto mileage rate 2012 up to four cars at a time @ 55.5¢/mile (depreciation portion is 23¢)
    • note that the medical & moving mileage rates are 23¢/mile
    • the charitable purposes mileage rate is 14¢/mile
  • auto mileage rate 2011 up to four cars at a time @ 51¢/ mile thru Jun.  Jul to Dec @ 55.5¢ (depreciation portion is 22¢)
    • note that the medical & moving mileage rates are 19¢/mile thru Jun.  Jul to Dec @ 23.5¢
    • the charitable purposes mileage rate is 14¢/mile
  • auto mileage rate 2010 up to four cars at a time @ 50¢/mile (depreciation portion is 23¢)
    • note that the medical & moving mileage rates are 16.5¢/mile
    • the charitable purposes mileage rate is 14¢/mile
  • auto mileage rate 2009 up to four cars at a time @ 55¢/mile (depreciation portion is 21¢)
    • note that the medical & moving mileage rates are 24¢/mile
    • the charitable purposes mileage rate is 14¢/mile
  • auto mileage rate 2008 up to four cars at a time @ 50.5¢/mile thru Jun.  Jul to Dec @ 58.5¢ (depreciation portion is 21¢)
    • note that the medical & moving mileage rates are 19¢/mile thru Jun.  Jul to Dec @ 27¢
    • the charitable purposes mileage rate is 14¢/mile
  • auto mileage rate 2007 up to four cars at a time @ 48.5¢/mile
    • note that the medical & moving mileage rates are 20¢/mile
    • the charitable purposes mileage rate is 14¢/mile
  • auto mileage rate 2006 up to four cars at a time @ 44.5¢/mile
    • note that the medical & moving mileage rates are 18¢/mile
    • the charitable purposes mileage rate is 14¢/mile, there's special rates for Katrina
  • auto mileage rate 2005 up to four cars at a time @ 40.5¢/mile thru Aug. Sept to Dec @ 48.5¢
    • note that the medical & moving mileage rates are 15¢/mile thru Aug. Sept to Dec @ 22¢
    • the charitable purposes mileage rate is 14¢/mile, after Aug 24th there's special rates for Katrina
  • auto mileage rate 2004 up to four cars at a time @ 37.5¢/mile
    • note that the medical & moving mileage rates are 14¢/mile
    • the charitable purposes mileage rate is 14¢/mile
  • auto mileage rate 2003 one car at a time @ 36¢/mile
    • note that the medical & moving mileage rates are 12¢/mile
    • the charitable purposes mileage rate is 14¢/mile

    • A taxpayer may not use the business standard mileage rate for a vehicle after using any depreciation method under the Modified Accelerated Cost Recovery System (MACRS) or after claiming a Section 179 deduction for that vehicle. In addition, the business standard mileage rate cannot be used for more than four vehicles used simultaneously.

      These and other requirements for a taxpayer to use a standard mileage rate to calculate the amount of a deductible business, moving, medical, or charitable expense are in Rev. Proc. 2010-51. Notice 2012-72 contains the standard mileage rates, the amount a taxpayer must use in calculating reductions to basis for depreciation taken under the business standard mileage rate, and the maximum standard automobile cost that a taxpayer may use in computing the allowance under a fixed and variable rate plan

      To use the standard mileage rate, you must own or lease the car and:

      • You must not operate five or more cars at the same time, as in a fleet operation,
      • You must not have claimed a depreciation deduction for the car using any method other than straight-line,
      • You must not have claimed a Section 179 deduction on the car,
      • You must not have claimed the special depreciation allowance on the car,
      • You must not have claimed actual expenses after 1997 for a car you leased, and
      • You cannot be a rural mail carrier who received a "qualified reimbursement."

      Further, to use the standard mileage rate for a car you own, you must choose to use it in the first year the car is available for use in your business. Then, in later years, you can choose to use the standard mileage rate or actual expenses.

      However, for a car you lease, if you choose the standard mileage rate, you must use the standard mileage rate method for the entire lease period (including renewals).

      To use the actual expense method, you must determine what it actually costs to operate the car for the portion of the overall use of the car that is business use. Include gas, oil, repairs, tires, insurance, registration fees, licenses, and depreciation (or lease payments) attributable to the portion of the total miles driven that are business miles.

      Other car expenses for parking fees and tolls attributable to business use are separately deductible, whether you use the standard mileage rate or actual expenses.

      http://www.irs.gov/taxtopics/tc510.html

    home office expenses2.
  • maid service and cleaning
  • unreimbursed expenses (if business entity's papers are properly documented)
  • on-premises athletic facilities (if your business entity is properly designed)
  • fully deductible medical & health care expenses or even a §501(c)(9) VEBA trust (if the plans are properly designed) - Note effective in 2006, IRS is attacking "abusive VEBA plans" that are promoted elsewhere on the internet.
  • child care and other §125 cafeteria plan deductions (if the plan is properly designed)
  • other fringe benefit plans (if the plans are properly designed)
  • 50% deductible restaurant meals had with friends who are fellow daytraders, lawyers, bankers, advisors
  • Meals Deductible Percentage Under 274(n)(3)
    55% for years beginning in 1998, 1999
    60% for years beginning in 2000, 2001
    65% for years beginning in 2002, 2003
    70% for years beginning in 2004, 2005
    75% for years beginning in 2006, 2007
    80% for years beginning in 2008, 2009
    Section 274(n)(3) provides a special rule that increases the percentage that can be deducted for meals of persons, such as truck drivers, who are subject to the hours of service limitations established by the Department of Transportation.

  • gifts to friends and 50% deductible entertainment with people who are fellow daytraders, lawyers, bankers, advisors
  • all the above with your spouse (if business purpose is properly documented and conducted)
  • 100% deductible §119 daytrader's daily pizza and Chinese take-out wink! meals (if your c-corp or other entity is properly designed)
  • 100% deductible §119 daytrader's monthly residence rent payments (if your c-corp is very strictly and properly designed)
  • charitable contributions
     
  • Other Tax Deductions and Your Small Business
     


Commissions paid to your brokers are capitalized and applied to reduce capital gain or increase capital loss when you sell the stock.

In spite of this favorable "trade or business" treatment, a trader's net gains are not subject to Self-Employment tax, under IRS Code §1402 (a)(3)(A) (but they are of course subject to the Income tax)

Taxpayers who qualify to file as Trader Status may "elect" such classification each year by a filing an appropriate tax return with the IRS.



Practical thoughts - things that support your position that you or your entity truly are in a for-profit trade or business:

  • Open a checking account for the business, separate from a personal use account
  • Obtain a credit card for the business, separate from a personal use card
  • Take a training class, attend a seminar, buy books on how to make the business profitable
  • Set up a budget for the business and/or a projection showing goals and profit ability in future years
  • Document you plans, at least annually showing goals for the year to make the business profitable


A Trader's Responsibilities


Additional informational overview sites:
Distinguishing Traders from Investors
Tax Rules for Day Traders
Tax Issues for "Traders" - Part I
Tax Issues for "Traders" - Part II
IRS Guidance - Special Rules for Traders in Securities
IRS Guidance - FAQ about Day Traders
Securities trader reporting requirements




1 Mostafavi, California State Board of Equalization, July 1, 2005, The taxpayer was not in the business of being a day trader and was not entitled to related business expense deductions, because he did not trade frequently, regularly, and continuously throughout the year and his trading activity was not the primary source of his income during the year. The taxpayer conducted only 238 trades on 83 days during the year, and he had a full-time job as a field sales engineer.


2 Deduction for Business Use of Your Home

One provision of the 1997 tax act, which was delayed to be effective for years after 1998, greatly relaxes the rules that must be met in order to deduct business use of your home.

A major change is the elimination of the rule that required the office be your "principal place of business" -  the place where you meet with customers or the place where you generate most of your income. That is not the current requirement.

The new rule is a simple test requires that the use of the office be an "ordinary and necessary" expense for the business and, unless this is the only fixed location of the business, it must be the only place available where you can perform the necessary "administrative or managerial" functions of the business.

Note that this does not change the requirement that the office must be used "totally and exclusively" for the business, and have no other use whatsoever. This is very strictly interpreted, and any degree of non-business use will disqualify the office. (Theoretically, if you have your computer in your home office, and sometimes use it to track personal investments, surf the web, or play an occasional game that can cause you to lose all deductions for use of the home office for the year.)

Also, if the use of the office is as an employee, that use must clearly be solely for your employer's convenience, not yours. If you are provided a suitable place to work by your employer (even if that means a 25 mile drive to the office in the middle of the night, when you are on-call to return customer emergency calls), that precludes you from claiming deductions for use of your home.

Note that, if your office in home qualifies for a deduction under the revised laws, it can be considered a "place of business" for determining your deductible business mileage, therefore it would not be non-deductible commuting.

The office in the home deduction generally is limited to an amount not to exceed your trading profits less your trading expenses. The excess office in the home deduction may be carried forward to be used in the following year(s).

Pass-thru entity unreimbursed expenses require proper documentation and must have no waived right for reimbursement.

  Mark-to-Market/font>
   
Taxpayers who qualify to file as Trader Status may optionally elect, by a filing with the IRS, to irrevocably use as their accounting system the "Mark-to-Market" method. This accounting method treats what would normally be Schedule D "capital gains and losses" as "ordinary
gains and losses" and also exempts these "ordinary gains and losses" from the wash sale rule.

Click here for some other features of a
Mark-to-Market Trader.



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