Before Using an Entity
If you are ready to form your trader entity, you can sign up for ENTITY FORMATION TAX CONSULTING here.
New Entity Tax Consulting – Business Formation and Incorporation Tax Consulting Services…
S-Corporations, multi-member LLCs and other legal entities as well as Partnerships, Joint Ventures, Joint Accounts and Certain Joint Undertakings with Fellow Traders or Family Members may be effectively used for trading vehicles.
You can do it yourself, using TraderStatus.com for assistance with the income tax aspects. We can assist you and your lawyer with LLC and S-Corp or C-Corp entity’s in all 50 States. Before accepting new clients we need to briefly review your goals to make sure you are ready to make the step in this direction. Your LLC or S-Corp can be up and running in as little as a few days with expedited service (in those States that offer expedited service), or a few weeks with the State’s regular service. We require a $800.00 nonrefundable retainer to become a client from which our $500 flat fee for income tax advice on forming and planning your entity is drawn.
Use your own credit card to directly charge the other fees (Secretary of State fee, etc.) Your retainer payment may also be made by credit card using the order form or send a check payable to “Colin M. Cody, CPA.” Telephone or email us to talk about your concerns.
Domestic vs. Foreign entity formation. Some businesses prefer to organize with a Secretary of the State other than where the owners of the entity are residents. In such a case the entity needs to hire a Registered Representative that resides in the state of formation. Often the entity then should also take steps to register as a foreign entity in the state where the owner resides and operates the business (and incur additional/duplicate fees). Each state may have its own rules as to how much presence in their state results in a legal requirement to register as a foreign entity. See a discussion at this link: “DOING BUSINESS” IN NEW YORK: AN INTRODUCTION TO QUALIFICATION General Guidelines
New York example: For the New York qualification requirement to apply, the local or intrastate contacts with New York must be permanent, continuous, and regular. Netherlands Shipmortgage Corp. v. Madia, 717 F.2d 731, 1984 A.M.C. 141, 72 A.L.R. Fed. 562 (2d Cir. 1983) (“New York courts have repeatedly and recently affirmed the vitality of this standard which requires the intrastate activity of a foreign corporation to be permanent, continuous, and regular for it to be doing business in New York. [Citations omitted.]”)
See statutes at these links: CALIFORNIA CORPORATIONS CODE SECTION 2100-2117.1
CALIFORNIA CORPORATIONS CODE SECTION 17708.01-17708.09
California example: 2105. (a) A foreign corporation shall not transact intrastate business without having first obtained from the Secretary of State a certificate of qualification.
17708.02. (a) A foreign limited liability company may apply for a certificate of registration to transact business in this state by delivering an application to the Secretary of State for filing on a form prescribed by the Secretary of State. The application shall state all of the following:
17708.03. (a) A foreign limited liability company that enters into repeated and successive transactions of business in this state, other than in interstate or foreign commerce, is considered to be transacting intrastate business in this state within the meaning of this article.
(b) Without excluding other activities that may not be considered to be transacting intrastate business in this state within the meaning of this article, activities of a foreign limited liability company that do not constitute transacting intrastate business in this state include all of the following:
(3) Maintaining accounts in financial institutions.
Domestic vs. Foreign are legal considerations, not necessarily income tax issues, so much. Therefore, these topics should be discussed with a good corporate lawyer before forming any entity.
Most traders start out as individual sole proprietorships (Form 1040, Schedule C). Some observations regarding Schedule C:
- If mark-to-market is desired, generally you must notify IRS that you elect in advance of filing your tax return – sent via certified mail between the dates of January 1 and April 15 of the year that mark-to-market is to begin.
- ○ This is more cumbersome than a separate newly formed entity which elects mark-to-market when it is formed or when operations begin, but does not actually notify IRS until its first separate tax return is filed.
- ○ Note that SMLLCs generally do not file their own separate tax returns, therefore making a retroactive election under the guise of a newly formed SMLLC is foolhardy at best.
- IRS audits are primarily targeted at individuals (Form 1040), and among individuals they are more specifically targeted at those filing Schedule C and showing a loss.
- ○ Traders, by definition, show a loss on Schedule C. That’s where your expenses are deducted, whereas your trading gains are reported on Schedule D or Form 4797.
- ○ It is generally inappropriate for a trader to reclassify any portion of interest income, dividend income, trading gains or losses from Schedule B, Schedule D or Form 4797 to Schedule C to obfuscate the Schedule C loss. By law, only a Securities Dealer is required to report gains and losses on Schedule C.
- ◙ Taking this improper position could result in an underpayment or overpayment of tax, but often this is not too serious an amount for IRS and State tax purposes – though it can occasionally have significant implications.
- ◙ Taking this position to obscure the proper reporting of your deductions can be a violation of IRS procedures subject to penalty (unless Form 8275 or 8275-R is filed).
- ◙ While the odds are with you against getting caught in a random audit and penalized for taking this kind of position, if you are selected for audit you run the risk of being pegged as an uncooperative adversary at worst or a poor tax preparer at best, making the audit itself more difficult to satisfactorily complete.
- ◙ To date, over 50% of the IRS audits we’ve handled here (of tax returns that were initially prepared elsewhere) have been triggered specifically because the preparer reported some portion of trading gains and losses on Schedule C, and the IRS then sent the tax return to an agent/examiner to investigate.
- Individuals selected for audit typically find their position of trader status under scrutiny.
- ○ If the trader also has W-2 wages, the standard line from the IRS is that that is your gainful employment and that the trading is merely an investment activity.
- ○ If the trader has significant investment income, the standard line form the IRS is that your trading is merely more of the same investment activity.
- ○ If the trader has investment income generally a portion of his expenses need to be allocated between trading and investing. Expenses allocated to investing are generally limited in their usefulness.