However, some traders can choose a professional trader statustrader profession classifying their trading as a business and using the mark-to-market method of accounting if trader profession satisfy the applicable tax rules. A professional trader aka trader in securities is one who engages in trader profession as a business. As a consequence, all normal or necessary expenses are deductible, and the professional trader can set up qualified retirement accounts to take advantage of the tax benefits offered by such accounts.
The professional trader can also deduct relevant educational seminars, including travel and lodging expenses, expenses that a casual investor cannot deduct at all. However, probably the greatest benefit to electing the professional trader status is that no Trader profession Security or Medicare taxes have to be paid on the income, which is equal to about The savings on any income above that limit will only be the 2. Because a professional trader must use mark-to-market MTM accounting, there are no long-term capital gains or losses, trader profession all open positions must be mark-to-market by yearend.
Hence, all income or loss is treated as ordinary income or loss. However, this tax treatment has significant advantages:. Professional traders can also have investment accounts that are treated according to the usual tax rules that apply to investments, but they must be identified trader profession such on the day that the security is acquired; most often, this is done by keeping investments in a separate brokerage account. The professional trader trader profession deduct many more types of expenses than a casual trader, without limitation.
So if a casual investor claims the standard deductionwhich most do, then even these limited investment expenses cannot be deducted. There is also an itemized deduction phase-out rule for claiming itemized deductions, reducing the deduction for higher income taxpayers.
For instance, professional traders can deduct the full cost of any educational courses, as long as they did not take the courses to actually enter the profession. Since the professional trader status does not require a license, it would be difficult to prove that the course was taken to enter a new profession. Hence, most courses taken after the trader profession of professional trader status will probably be deductible if it clearly benefits trading. On the other hand, a casual investor cannot deduct any such courses at all.
Likewise, the casual investor cannot deduct meals and entertainmenttrader profession mileagehome office expensescell phones, and trader chat room fees.
However, any investment losses incurred before attaining professional trader status cannot be used to offset professional trader income. Professional traders must also pay quarterly estimated taxes. Since income can vary widely throughout the year, the quarterly payments may be a lot more or a lot less than what could have trader profession paid given the final income for the tax year.
Overpayments, of course, will be refunded when the trader files his tax returns after the end of the tax year. According to the Taxpayer Relief Act oftrader profession in securities engage in a trade or business involving active sales or exchanges of securities on the market, not by trading with customers.
However, professional trader status is not defined by the tax code — it is defined by IRS guidelines and case law. Hence, there is some risk in electing the professional trader status, especially since there trader profession no bright lines distinguishing the professional trader from the casual investor in the IRS guidelines, or the court record, for that matter. Factors that the IRS considers when determining whether trading is actually being conducted as a business include the following:.
The trading of securities is only considered a business for those securities that satisfy the trading requirements. Any other securities held by the investor are trader profession an investment rather than a business, and thus, subject to the investment trader profession.
Records must be kept to distinguish between those securities traded as a business and those that are traded as an investment, since they are subject to different tax rules, which is generally done by keeping them in separate accounts.
If long-term investments are commingled with the short-term investments in the same account, then the owner's professional trading status may be in jeopardy, since the Trader profession regularly audits professional traders.
Trading as a business is reported in the same way that any trader profession reports its income and trader profession, by filing Form trader profession, Schedule C, Profit or Loss from Business. Other advantages of trading as a business using the mark-to-market method of accounting is that there is no limitation on trader profession deductibility of investment interest expenses.
The gains earned from selling securities are not subject to self-employment tax, since any gains or losses are reported on Part 2 of FormSales of Business Property. A distinct disadvantage to the professional trader status is that the trader must use mark to market accounting, which is more complex than recording sales and profits or trader profession. Furthermore, all capital gains and losses from trading securities are treated as short-term, so none of these trades in the professional trading account will qualify for the lower long-term capital gains rate.
The election must be made before the non-extended due date of the previous tax year. So the deadline for making the election for is Tax Day in April, Since the mark-to-market election requires a change of the accounting method for reporting gains and losses, the taxpayer must file FormApplication for Change in Accounting Method.
If the request conforms to Revenue Procedurethen permission will be automatically granted. This election may only be revoked by receiving permission from the Trader profession, by re-filing Form to change the accounting method and paying a fee for the change. Judging by some court cases, trader profession IRS seems to require day trading or at least very short-term trades. Trades must also be conducted on most of the trading days during the tax year.
Additionally, most of the income must be earned from capital gains, not from interest or dividends. Otherwise, the IRS may decide that the professional trader is actually an investor, thereby revoking the trader profession trader status, which will incur a hefty liability of back taxes, penalties, and fines.
If the trader wants longer-term investments or investments that pay interest or dividends, then it should be done in a segregated account, outside of the business. The risk is that since there are no trader profession lines distinguishing the professional trader trader profession an investor, trader profession IRS may dispute the professional trader status.
It may be difficult trader profession win such a case, especially if the taxpayer is operating in a gray area.
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