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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.
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:
- 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.
- Do you
participate in your activity just for fun?
Playing the market for enjoyment of it and not pursued for
significant profit.
- Do you
depend on income from the activity?
If so, your activity is likely considered a business.
- Have you
changed methods of operation to improve profitability?
If so, your activity may actually be a business.
- 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.
- 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.
- 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.
- 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:
-
The taxpayer's intent-
investment negates trader status.
-
Nature of the income from the
activity- only short term gains qualify as trading income.
-
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:
- the taxpayer's intent,
- the nature of the income to be
derived from the activity, and
- 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:
- the taxpayer's trading is
substantial, and
- 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:
- Working interests in oil and gas
activities;
[IRC § 469(c)(3), Reg. § 1.469-1T(e)(4)(v)]
and,
- 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
Topic 429 - Traders in
Securities (Information for Form 1040 Filers)
This topic explains if 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. The term
security is defined in Internal Revenue Code section
475(c)(2). In general, the term security includes a
share of stock, beneficial ownership interests in
certain partnerships and trusts, evidence of
indebtedness, and certain notional principal contracts,
as well as evidence of an interest in, or a derivative
financial instrument in, any of these items and certain
identified hedges of these items. Please refer to
section 475(c)(2) for a complete list of items that
qualify as a security. To better understand the special
rules that apply to traders in securities, it is helpful
to review the meaning of the terms investor, dealer, and
trader, and the different manner in which they report
the income and expenses relating to their activities.
InvestorsInvestors typically buy and sell
securities and expect income from dividends, interest,
or capital appreciation. They buy and sell these
securities 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
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. They report
these expenses on
Form 1040, Schedule A (PDF),
Itemized Deductions, as miscellaneous
deductions allowable to the extent that they exceed 2%
of adjusted gross income. They can also deduct interest
paid for money to buy or carry investment property that
produces taxable income 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.
Investment income is not subject to self-employment tax.
For more information on investors, refer to
Publication 550,
Investment Income and Expenses.
DealersDealers in securities may be
individuals or business entities. Dealers purchase,
hold, 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
and derive their income from marketing securities for
sale to customers. Section 475 requires dealers to keep
and maintain records that clearly identify securities
held for personal gain versus those held for use in
their business activity. Dealers must report gains and
losses associated with dispositions of securities by
using the mark-to-market rules discussed below.
TradersSpecial rules apply if you are a
trader in securities, in the business of buying and
selling securities for your own account. The law
considers this to be a business, even though a trader
does not maintain an inventory and does not have
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.
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
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 ElectionTraders can
choose to use the mark-to-market rules, investors
cannot. If a trader does not make a valid mark-to-market
election under section 475(f), then he or she must treat
the gains and losses from sales of securities as capital
gains and losses and report the sales on
Form 1040, Schedule D (PDF),
Capital Gains and Losses and on
Form 8949 (PDF),
Sales and Other Dispositions of Capital Assets,
as appropriate. When reporting on Schedule D, both the
limitations on capital losses and the wash sales rules
continue to apply. However, if a trader makes a timely
mark-to-market election, then he or she can treat the
gains and losses from sales of securities 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. Neither the
limitations on capital losses nor the wash sale rules
apply to traders using the mark-to-market method of
accounting.
In general, a trader must make the mark-to-market
election by the due date (not including extensions) of
the tax return for the year prior to the year for which
the election becomes effective. You can make the
election by attaching a statement either to your income
tax return or to a request for an extension of time to
file your return. The statement should include the
following information:
- That you are making an election
under section 475(f);
- The first tax year for which the
election is effective; and
- The trade or business for which you
are making the election.
Refer to the
Form 1040, Schedule D Instructions (PDF),
Capital Gains and Losses, for more
information 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 2011-14 (revenue procedures are
available on IRS.gov).
In addition to making the election, you will also be
required to file a
Form 3115 (PDF),
Application for Change in Accounting Method.
Publication 550 describes the procedures for making
an election under the section called "Special Rules for
Traders in Securities."
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.
Comment: The
above paragraph does not reflect the "exclusive method,"
that has been in effect since
January 16, 2015,
for
revoking valid or invalid elections . See Rev.
Proc. 2015-14 section 23.02(2).
Above IRS Tax Topic was Last Reviewed or
Updated: March 06, 2015
and Page Last Reviewed or Updated: April 24, 2015
(no changes were made
between March 6, 2015 and April 24, 2015)
and Page Last Reviewed or Updated: May 12, 2015
(no changes were made
between April 24, 2015 and May 12, 2015)
The changes in the various revisions from 2010 through 2014 are
shown below:
Additions/Deletions/Deletions/Deletions/2011Additions/2013
Additions/2014
Additions/2015
Additions over the years are indicated by the colored edits inserted below.
Please use the IRS link above to read the current version
without seeing all the clutter of the ensuing changes.
-
Topic 429 - Traders in Securities (Information for Form 1040 Filers) This
tax topic explains
whether
if 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.
(deleted December 2015>
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. <deleted
December 2015)
The term security is defined in Internal Revenue
Code section 475(c)(2). In general, the term
security includes a share of stock, beneficial
ownership interests in certain partnerships and
trusts, evidence of indebtedness, and certain
notional principal contracts, as well as evidence of
an interest in, or a derivative financial instrument
in, any of these items and certain identified hedges
of these items. Please refer to section 475(c)(2)
for a complete list of items that qualify as a
security. To better understand the special rules
that apply to traders in securities, it is helpful
to review the meaning of the terms investor, dealer,
and trader, and the different manner in which they
report the income and expenses relating to their
activities.
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.
They report 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.
They can also deduct
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.
Investment income
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,
and 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
Section 475 requires dealers to
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.**
The law considers this to be
This is considered
a business, even though
a trader does not
you do not
maintain an inventory and
does
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.
(the December 2014 version of the above paragraph is shown below
without the clutter of the changes)
Traders can choose to use the mark-to-market rules,
investors cannot. If a trader does not make a valid
mark-to-market election under section 475(f), then
he or she must treat the gains and losses from sales
of securities as capital gains and losses and report
the sales on
Form 1040, Schedule D (PDF), Capital Gains and Losses and on
Form 8949 (PDF), Sales and Other Dispositions of Capital
Assets, as appropriate. When reporting on Schedule
D, both the limitations on capital losses and the
wash sales rules continue to apply. However, if a
trader makes a timely mark-to-market election, then
he or she can treat the gains and losses from sales
of securities 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. 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.You
can make the election
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:
- That you are making an election under section 475(f)
of the Internal Revenue Code;
- The first tax year for which the election is effective; and
- The trade or business for which you are making the election.
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.
(the December 2014 version of the above paragraph is shown below
without the clutter of the changes)
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 2011-14 (revenue procedures
are available on
IRS.gov). In addition to making the election,
you will also be required to file a
Form 3115 (PDF), Application for Change in
Accounting Method.
Publication 550 describes the procedures for
making an election under the section called "Special
Rules for Traders in Securities."
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
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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
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 2015 up to
four cars at a time @ 57.5¢/mile (depreciation portion is
24¢, most of the remainder is based on insurance, repairs and fuel)
- note that the medical & moving mileage rates are 23¢/mile
(based mostly on fuel cost)
- the charitable purposes
mileage rate is 14¢/mile (this rate is fixed by law)
- 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
- was 100% deductible prior to 1987
- was
80% deductible from 1987 to
1993
-
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
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.
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