Maintaining Trader Status

The Eighth Circuit upheld the Tax Court in ruling that a taxpayer’s business was not truly a trade or business and therefore all deductions associated with it were disallowed.  (Montagne v Comr., No. 04-4137 8th Cir 2/7/2006 see links: here, here or here )

Reasons stated for believing that the taxpayer was not truly operating a business:

  • he did not have a written business plan
  • he did not have financial projections
  • he did not have a separate bank account for the business, rather he paid business expenses out of the personal checkbook
  • he failed to generate separate business records for the business activities
  • he failed to develop economic expertise in the business
  • he did not solicit expertise from others regarding his business

Traders should take heed:

  • each year purchase books and research material from the bookstore and save the receipts
  • subscribe to IBD, WSJ, Barrons, and several trader magazines, and retain those dog-eared copies to show the IRS examiner
  • keep taking continuing education seminars & classes
  • subscribe to internet chat rooms for education and market information
  • keep a separate brokerage account for the business activity
  • open a separate checking account for the trading expenses
  • obtain a separate credit card for trade business expenses
  • keep all business receipts
  • document your travel and automobile mileage
  • document your entertainment and meals listing Who was there; When it was; Where it was at; What was discussed about the business; How much was spent; What was the business relationship of the guests you were with. (a credit card receipt documents many of these, so you might simply write the other items on the receipt while you are filling in the tip)
  • download and maintain proof of your activity: trade confirmations, multiple fills, unfilled limit orders, other activities accomplished throughout the day. keep copies on a thumb drive or CD-R for safekeeping.
  • maintain an excel spreadsheet or use Quicken or other software to track your activity each week, or preferably each day
  • take pictures of your office from time to time showing a business-like operation. (the area must be used exclusively for business, so make sure the ironing board and the kids’ rocking horse are relocated before converting to a business office)
  • keep a diary of your activities, your telephone contacts, your automobile travel and so on
  • save stuff for at least three or four years. the IRS can get a good impression if you can show them the by-products of your research and technical analysis etc.
  • obtain and save monthly brokerage statements and annual summaries
  • maintain executed securities trades in a format similar to the IRS Schedule D and From 7949
  • retain a professional (CPA, EA, Tax Attorney) to assist you
  • form an entity to run the business through and make sure it timely files its own separate tax returns
  • hire helpers and pay them via actual payroll and issue them each a W-2 at year’s-end.
  • maintain an office. a home office is great, an outside office is even better!
  • have several monitors and a television in use to track the markets
  • have live data feeds for real-time quotes, charts, breaking news
  • have critical back-up: multiple computers and multiple means of accessing the markets etc.