Tax-advice Hall of Shame

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Daytrader and tax sites

One of the reasons TraderStatus.com was started was to offer an oasis from the glut of well-meaning but sometimes totally meshugeh tax mis-information found on the internet.

Disclaimer: The following items are presented for educational purposes and discussion only, responsible commentary including that with a contrary viewpoint is welcome.

Send us your most outrageous nominees by writing to: forshame

Here we see an expert who apparently believes that the sale of stock is subject to Social Security tax...

http://www.individualinvestor.com/investor_university/article.asp?ID=6308 (as of October 31^st)

Have a question?
Ask Our Experts

Q. How will I get taxed on a stock I held less than a year? -- Neal K.

A. Any stock that is bought and then sold within one year is considered a short-term investment; as such, it is taxed as ordinary income.

If you hold a stock for longer than a year, your taxes on the investment will be much lower because the IRS has established a special tax rate (well, actually it was Congress, but no matter...) to encourage investors to provide steady capital for companies that are trying to grow. Be aware that to calculate the length of time you held the security, the IRS looks at the trade date (i.e. the date the order was executed).

So, if you're in the 15% tax bracket, your long-term gains will be taxed at a rate of 10%. If you're in any bracket above 15%, your long-term gains will be taxed at a rate of 20%. Short-term gains will be taxed at your normal bracket rate. Also, short-term gains are subject to Social Security (FICA) and Medicare taxes because they are equivalent to income. (Hmmm, really?? Well, fortunately for investors and traders Congress specifically excludes anything which is considered a gain or loss from the sale or exchange of a capital asset, like the capital gains from sales of stock, under IRS Code §1402(a)(3)(A)...)

Portions of the above are Copyright © 1997-1999 Individual Investor Group. All Rights Reserved and are reprinted here for example and educational purposes only.

Some "advice" from the pros on how to qualify for trader status...

Here's an expert who apparently does not know how a taxpayer qualifies for trader status...

http://www.dtonline.com/taxguide98/invest.htm (as of October 31^st)
http://www.dtonline.com/taxguide99/invest.htm(as of May 2^nd)

5. Determine whether you are an investor or a trader. Most individuals who buy and sell securities for their own accounts are usually considered investors. Their main purpose is to realize and maximize investment income, that is, interest, dividends, and the gain associated with the appreciation of the underlying security. An investor is allowed a deduction for his or her expenses as an itemized deduction subject to the 2-percent floor limitation and the 3-percent phaseout. (A trader is not subject to these limitations.) Conversely, a trader will not be as interested in the interest or dividend yield as much as in the profit from the short-term swings in the market. A trader or someone in the trade or business will deduct expenses against his or her profit. Note that recent court cases require that, to qualify as a trader, you must do transactions for others, not just yourself. (What can we say? Our guess here is that they are thinking of the case of a securities trader: Marrin v. Comr., No. 97-4080, 2d Cir. (6/9/98) which turned on the so-called "to customers" requirement. But this case, in effect, said exactly the opposite: that a trader does not sell to customers...)

Portions of the above are Copyright © 1998 Deloitte & Touche LLP. All rights reserved and are reprinted here for example and educational purposes only.

Having your retirement plan contributions retroactively revoked puts you in a fine kettle of fish...

Possibly here the difference between what it means to be in the "trade or business" (of securities trading) and the basic requirements for a Keogh retirement plan needs to be clarified a little more...

http://www.xxxxx.com/interviews/xxxxxx.shtml(as of October 31^st)

Can a daytrader fund a Keogh? If not, what alternatives are there?

Absolutely. If the trader has done the proper paperwork to obtain professional trader status, they can fund a Keogh, Simple IRA, Regular IRA, SEP IRA, or a Defined Benefit plan. If they have not completed the proper paperwork then they are not considered to be conducting a "trade or business" and their options are severely limited. In this case they most likely will be limited to a regular IRA. (When speaking of a Keogh retirement plan in this way, "trade or business" is off point. With a Keogh plan it is "earned income" which is required, not necessarily just a "trade or business." The "trade or business" of securities trading itself does not generate any earned income in this sense, and therefore is not allowed a Keogh deduction, under IRS Code §401(c)(2)(A)(i). When desirable, traders are able to generate "earned income" with some creative use of an S-Corporation, however corporations are prohibited from having Keogh plans...)

Portions of the above are Copyright © 1999 and are reprinted here for example and educational purposes only.

This is an all too common fallacy...

http://ramresearch.com/cardtrak/pastissues/ct_nov91.htm (as of November 16^th)

the IRS has also phased out the personal income tax deduction for credit card interest, which increases the real cost of high rate cards.

http://www.adataco.com/Newsletter/article9907.htm (as of November 16^th)

home mortgage interest is tax deductible for individual taxpayers, while credit card interest is not.
Fact is "personal interest" is what is not deductible. If you happen to borrow on a credit card for a personal trip to Las Vegas, yes, that is not deductible. Just the same if you withdrew $10,000 from your margin account for the Las Vegas trip, the margin interest on that $10,000 would not be deductible. What matters is the use of the funds borrowed, not whether the source of those funds happens to be your MasterCard or not! Funds borrowed to purchase stocks as an investment (even if they came from your MasterCard) are generally deductible investment interest. Similarly if you use the MasterCard for trading stocks, generally it is trader status business interest.

but here's a sharp guy who got it correctly!
http://www.smbiz.com/sbw2048.html (as of November 16^th)

In Valerie Jean Genck (T.C. Memo. 1998-105) the Tax Court allowed the taxpayer to deduct personal credit card interest incurred with respect to business expenses. Note. Be sure your facts are on solid ground. That is, that you can trace the interest expense to the business expense.

Portions of the above are Copyright © CardWeb.com, Inc., A/N Group, Inc., Ambrosi Donahue Congdon & Co., P.C. and n-Commerce, Inc. All rights reserved and are reprinted here for example and educational purposes only.

Retirement plan advice that is 180 degrees backwards...

http://www.quicken.com/cms/viewers/article/taxes/3689 (as of December 6^th)

Goof-Proof Active Trading
Your best bet is to restrict your active trading to your tax-free or tax-deferred account like your traditional or Roth IRAs. You can make trades all day long in your IRA and never worry about reporting anything to the IRS. Fill your taxable accounts with more stable, tax-friendly long-term securities that you don't plan on selling for a while. Keep in mind, though, that when you make stock trades in your IRA you'll want to pay your commissions with after-tax dollars. Commissions withdrawn from IRA funds will be hit by the same 10% penalty that an early withdrawl would be charged.

Xxxxxx Xxxx, based in Xxxxx, Xxxxx, is a tax professional specializing in individuals and small businesses.

Fact is that commissions on stock trades in an IRA are considered an expense of the IRA. You are not treated as taking a withdrawal when you pay those commissions from IRA funds. On the contrary, if you pay normal brokerage trading commissions from non-IRA funds you most likely will be deemed to have made an extra contribution to the IRA. If you've previously hit your maximum for contributions, the result is an excess contribution, which entails a penalty. (There is an exception for a special arrangement where the amount of brokerage commissions, administrative fees, and service fees are billed directly by the IRA custodian to the customer and are paid separately by the customer: PLR8432109, but be aware that this may be in conflict with Revenue Ruling 86-142). Unfortunately (as shown below) much information on the Web is there to drive traffic, "eyeballs," not necessarily to provide meaningful, or even accurate information.

On this one we pointed out the error to the copyright holder. Here is the response, let's see if they fix it...
Quicken.com:-Thank you for your comments & continuing interest in Quicken.com Your feedback is always appreciated and will enable us to continue to make our site the best it can be. Leo Internet Support Group Quicken.com Member Services.
Quicken.com, in response to our 2nd inquiry when nothing was done:-We suggest you contact Mr. Xxxxxx for any questions about his article. J, Internet Support Quicken.com Member Services.

Update: To their credit, Quicken.com did act (as on December 26, 1999) to correct their web site in accordance with accurate information contained on the TraderStatus.com web site:

And they removed the reference to their trader status expert.

Quicken.com, in further response:- That was a regrettable error on the part of an editor (not Xxxxxx Xxxx [the professional]). Since that error, Quicken.com has made every effort to make sure that everything posted on the site is as accurate as possible. [The] professional [was] not at fault, and in fact was the one who pointed out the error in the first place. DRG Assistant Managing Editor. Amazingly, the editor here chooses to proclaim that his original author was the one who first pointed out the error. This in spite of their written reply (above) telling us that we are incorrect and condescendingly suggesting that we contact their author for further "insight" from the professional! The site is basically there to drive web traffic.

Portions of the above are Copyright © 1997-1999 Intuit Inc. All rights reserved and are reprinted here for example and educational purposes only.

First year M2M misinformation...

http://www.thestreet.com/funds/taxes/880943.html (as of April 2^nd)

More Forms to File
Traders who correctly made the election last year to mark to market in 1999 have a new form to file.

Form 3115 - Application for Change in Accounting Method must be included with the 1999 return. This form indicates that you're changing accounting methods. It's complicated and will take time and patience.

It gets worse. In the first year you change your accounting method, you must spread that mark-to-market net gain or loss over four years, says Dave Matthews, a manager in the financial instruments group at Deloitte & Touche in Boston. (Check out Section 481 for more details.)

Say you have a mark-to-market net gain of $20,000. If 1999 is the first year you're marking your trades to market, only 25% of that $20,000 is taxable in 1999. The remainder will be included in income over the next three years.

Since net gains are taxed at ordinary tax rates, this four-year spread is a good thing for traders who made money in 1999. But it could get ugly if you keep doing well. Continuing with the example above, say you have another good year in 2000 and wind up with a net gain of $15,000. You'll owe tax on that entire $15,000 gain, plus 25% of your 1999 net gain. This all sounds nice but unfortunately one might find himself or herself in the pokey following it! Currently accurate information is found in the TradersTaxPlan™ , "When preparing form 3115 you will need to compute the required §481(a) adjustment. The amount of this adjustment is computed as the difference between: (1) the fair market value of those trading securities held at the beginning of the year of the change (e.g. 1/1/2000) and (2) the adjusted tax basis of those same securities under the taxpayer's old method of accounting as of the close of the taxable year immediately preceding the year of change (e.g. 12/31/1999). Remember there is a special election available which exempts you from the 4-year phase-in rules (see form 3115 line 21a) for adjustments that total under $25,000. ." Early stage discussions while the IRS was formulating these new rules were as described at the above link. This was just one of the areas I suggested needed reworking and clarification of to the drafters before their final (temporary) rules were issued.

Portions of the above are Copyright © 2000 TheStreet.com All rights reserved and are reprinted here for example and educational purposes only.

Numerous errors from a day-trading broker's tax information page...

http://www.terranova-mb.com/xxx/ (as of October 18^th)

II. Trader in securities:

In 1997 a new classification of taxpayer was created termed a 'Trader In Securities.' In order to qualify as a Trader in Securities some stringent requirements must be satisfied, but primarily, a Trader in Securities is an individual who actively trades their account as if it were a job or profession. This means active ongoing trading with substantial time and effort involved among other things. Once you qualify as a Trader in Securities, many of the restrictive tax laws that apply to investors are relaxed. For example:

'The definition of qualifying deductible investment expenses is greatly expanded and therefore a greater amount of expenses may be written off.'

Investment expenses are no longer deducted as miscellaneous itemized deductions, but are now fully deductible business expenses. This includes margin interest, meals & entertainment, training, dues, publications, and other types of previously nondeductible expenses. There are substantial tax benefits for those individuals who qualify to be classified as a Trader in Securities. A Trader in Securities is often times referred to as a Day Trader.

III. Traders in Securities who elect mark to market accounting:

As stated, a Trader in Securities is essentially an individual who actively trades their account as if it were their job or profession. This type of trader is often times referred to as a “Day trader”. Once you qualify as a Trader in Securities you also have the option of electing “Mark to Market Accounting Treatment." If this election is made, the impact on your tax situation will be even more dramatic. For example, look at the benefits these taxpayer’s receive:

You no longer need to track individual stock trades when reporting your trading activity.
You no longer are subject to the Wash Sale Rules.
You can deduct all of your trading expenses without limitation, instead of having them treated as a restricted itemized deduction.
If you lost money trading, you can deduct all of your losses instead of being subject to the annual $(3,000) net capital loss rule. There is no limitation.
If you made money trading, you can shelter profits through retirement plans and other tax planning strategies.

This is the classification where you can save a tremendous amount of tax dollars if you qualify. We hope you didn’t lose money trading, but if you did you will be able to deduct the entire amount against your taxes. Plus you will no longer need to track individual stock trades throughout the year, or be subject to the wash sale rules. If you made money trading, you will have planning opportunities to drastically reduce taxes on your profits by establishing retirement plans, or other planning measures. All of these benefits are available to those individuals who meet the requirements of this classification and file the proper paperwork with the IRS.
The amount of misinformation in the few paragraphs above is nothing less than astounding. Some are just silly bits of off-the-wall misinformation, others are more seriously misleading. For starters, they claim that a new classification of taxpayer, a Trader in Securities, was created in 1997. How ridiculous! We have been advising Traders in Securities for more than a decade! The classification of Trader in Securities in the Tax Courts goes much further back to the early days of tax law. One easy example they could have looked up is IRS Revenue Ruling #521 from 1972 which covers the deductibility of margin interest by "traders in securities." The point being, the classification as a Trader in Securities is nothing new and has been with us for decades.

The investment expenses of a Trader in Securities continue to be deductible on Schedule A, just as for an Investor. Investment expenses go on Schedule A, they do not suddenly become deductible as trade or business expenses if they are expenses pertaining to investments. Traders in Securities do deduct their trading expenses (not their investing expenses) on Schedule C. This is an important distinction to be made and one that we see new clients for each year after they find themselves under audit with an improperly prepared return based on this, apparently, popular misconception.

Further, regarding the M2M election:- The Sec 475 M2M election in no way negates the need to track individual stock trades 1.. The M2M election does not eliminate the Wash Sales Rules for you, rather it eliminates the Wash Sales Rules for the activity within the one specific trade or business the election was made for. The M2M election does not make all your trading related expenses deductible without limitation; for example the Trader's Office in the Home deduction is limited to the net annual income from the trading activity. If you made money trading then the M2M election does not necessarily allow you to shelter profits through retirement plans. Retirement plans are totally independent of the M2M election.

One must wonder if they did any research at all before publishing their web page of purported "Important Tax Information For Our Clients!"

¹ You no longer need to track individual stock trades when reporting your trading activity -- NOT!
From the I.R.S. instructions for Form 4797 on how to report trades: "Securities or Commodities Held by a Trader Who Made the Mark-To-Market Election:- Attach to your return a statement, using the same format as line 10, showing the details of each transaction." Could anything be more clear?

Portions of the above may be Copyright © 1998 - 2000 MB Trading and Copyright © 2000 Internal Revenue Service. All rights reserved and are reprinted here for example and educational purposes only.

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