Hello, I am an U.S. (options) day trader, and I was hoping to tap the experience of similar traders with a couple tax questions. I'm not looking for binding, professional tax advice (I need to hire someone for that), I'm just hoping to check my methodology and research findings against people's experience. And this thread may help new, profitable day traders too. I have traded short term options off and on, but for various reasons, this year my motivation, effort and YTD performance is substantially better. Suppose my day job salary (reported on W2) is x, it is quite possible I could gross multiples of x in trading profit this year 2016. So I'll have to consider the tax implications. 1. Do I have to pay estimated taxes? My reading of the IRS literature suggests that if the final tax owed is more than 10% different than the tax paid during the year, there could be penalties. I think the answer is yes, I need to pay estimated taxes during the year. (I had the foresight to move to a state that has no state income tax.) 2. How much to pay? According to my research, the IRS divides up estimated tax payment periods into four periods, ending in March, May, September and December. The 15th after that period ends, the estimated tax is due. In concept, I need to calculate my capital gains during the period and pay estimated tax on the profits. Except, that for day traders, profit/loss may not be consistent. I may be profitable one period, and unfortunately lose money the next period. To me, if the IRS insists I pay estimated tax during the year, the only way I can think of is, if I am profitable during a period, pay tax on that amount. If I lose money, pay nothing, then subtract that loss into any profits in future periods. For example, if I am profitable $20,000 in the March period, pay taxes on that. Suppose I am down $8,000 in May, so pay nothing. Then in September, suppose I make $30,000. But subtract the $8,000, and calculate taxes based on a gain of $22,000. Does this methodology make sense, do others use it? 3. Tax rate? There are actually several capital gains tax rates. If an asset is held short term, the profits (capital gains) is taxed at the rate of ordinary income. All my trading is "short term", but with a wrinkle. Most of my trading (so losses and gains) is done in section 1256 contracts, broad based index options. The capital gains on these profits has a preferential tax rate: 60% of the lower "long term capital gains" rate and 40% the higher short term capital gains rate (ordinary income.) Does this mean that for tax calculation purposes, I need to separate my gains/losses into two buckets: one capital G/L bucket for section 1256 contract trading, and one G/L bucket for everything else (like equity options). Then calculate the tax for each bucket based on the bucket's specific tax rate? 4. Filing taxes. All options trading (capital gains/losses) is reportable on a Form 1099-B. Next year, the way things are going, I should have a very long 1099-B with hundreds of trades, and profits to report to the IRS. Do any of the popular online tax websites handle this situation more easily? If not, I'm just going to find a human tax preparer and hand him/her all of my paperwork. Thanks in advance for any experience or insight. Alan
1. estimated taxes. One year I had a killer 2nd quarter. up like well over 100%. I've been trading long enough to know that can't last. I may need that money later in the year when things normalize, so I skipped the quarterly or just sent them a token, and paid the penalty apr 15 on less profits. 1256 makes all cap gains 60/40 regardless of time held. So at end of year (or quarterly) all cap gains combined are taxed 60% long 40% short. it's not that complicated if you spend a weekend carefully reading through IRS PUB 539 and the above link
Redneck, Thanks for the pointer. I've seen GTT in a few places reading this forum, and I'll likely be contacting them. ETcallhome, thanks for your input, it is very valuable. I hadn't seen tax topic 429: https://www.irs.gov/taxtopics/tc429.html but it is a useful primer. Since most of my losses/gains are in section 1256 contracts, which have a preferential capital gains rate, I wouldn't want to make a mark to market election, which would treat all gains/losses as ordinary income. Trader status would enable me to deduct expenses, but those are non-expenses or inconsequential in my case. Thanks guys for getting me thinking about the right things. Alan
gkishot, This is a great question, and it depends on what your definition and tolerances are. The spread on at- or out-of-the-money index options are not high, maybe $0.30 or $1.00, 5% or 10% or less, of the option. The thing is, the S&P 500, for example, has a notional value of $1,800. However, I trade in the money, typically fairly deep in the money, index options. I want the high deltas. This is sort of replicating futures trading, at the disadvantage of the options cost (time value) and not 100% delta (so one point movement doesn't get me one point in options price movement), but at the advantage of leverage (can have many contracts) and no margin calls. If the S&P 500 is trading at 1900, and I'm looking at the short-term 1915 put, the bid/ask spread may be several dollars. However, an order at the midpoint of the bid/ask, or even a few dimes in _my_ favor, will typically get executed (unless the market just moved). From here, it only takes a 0.1% move there abouts to get to breakeven. A 0.1% move in the S&P 500 is but a blip, and that's even before the volatility since summer 2015. I hope this helps. Alan