Deducting trading expenses?

Discussion in 'Professional Trading' started by heech, Oct 15, 2009.

  1. heech


    Hi all,

    I've been trading "full-time", but not really for the last year. I have automated code executing 24/7, and trade about 1000 contracts a month. However, I also have a full time job in a different career.

    I've been told by my CPA (who seems competent, but doesn't specialize in trading issues) that trying to treat my trading as a business would not be possible, because the IRS sees my non-trading full time job as proof the trading side of things isn't my "business". This wasn't a major issue before, but trading-related expenses are starting to add up. Considering server hosting, data feeds, software, and other costs... I'm probably looking at ~$10k-$15k in trading-related expenses this year.

    Anyone have any input on this issue?
  2. Surdo


    Write it off, and get a new CPA that specializes in trader's accounting. Do you think the IRS knows you are not sitting at your screen 6 hours a day?
  3. I suggest that you read a few publications from the IRS and a few articles on the Internet about taxes on trading.

    Here's my take:

    - Anybody who works full time (taking a salary, W-2) can own one or more businesses at the same time. There is no law that says "because you have a full-time job, you cannot possibly own any businesses". Some people operate a laundry mat, a hotdog stand, whatever while they have a 40-hour per week job. It's perfectly all right. Trading is just like any other business - as long as you treat your trading as a business and not a hobby. That you are not an "investor" who pretends to be a trader to write off your expenses.

    - If you establish trading as your business, you can use Schedule C to deduct your business expenses, but use Schedule D to report your gain/loss from trading. Don't report your trading gain/loss as income in Schedule C. Or else IRS will require you to pay self-employment tax. You should be able to write off your trading expenses on Schedule C.

    To be a trader, you need to pass 2 tests:

    - Substantial activity test. With 1000 contracts traded a month, I don't think there should be any doubt on this.
    - Trading activity test (the main thrust of your activity is trying to capture short-term swings in market prices rather than profit from dividends and share appreciation.)

    Excerpts from some of the articles:

    - IRS Publication 550 now includes a short section on traders, with essentially the same information you'll find in the tax return instructions.

    Read up on them and decide for yourself.
  4. How much money do u make from your trading "business"? The ability to rack up expenses doesn't mean much in the absence of significant income.
  5. heech


    Awesome feedback, much thanks.
  6. BTW: I don't think that to be a trader (running a trading business) that you need to be in front of a screen for 6+ hours a day anyway. Some can trade 2-3 hours a day and that's it. It's still a business.

    And since you mentioned that it's automated trading, you don't need to sit in front of a screen at all. (Or may be attend to matters for only a few minutes a day). It's still a business.
  7. heech


    I think the Fairmark link above presents exactly how many CPAs, including my own, see the trader election issue:

    "Many individual investors . . . want to take the position that they are full-time traders for tax purposes so that they can deduct their expenses and elect section 475(f). . . . In court, these people have a snowball's chance in hell of prevailing. Numerous cases hold that individual day traders do not have a trade or business of trading securities."

    I mean, that's a pretty categorical statement. But for those who follow the link above, the argument is some individual traders *can* meet the requirement. On any reasonable standard (beyond the "snowball in hell" one), I think I should meet the requirement.
  8. the1


    Good response. You also have to demonstrate that your activity is continuous. If you trade for a month and then take time off you will have a hard time satisfying this requirement. If you try and deduct your expenses expect the IRS to challenge it.

    Find another person you can trust (spouse, mom, dad, or other) and form a Limited Partnership. I'm not a CPA so I don't know for sure but I think this will get you over the hump. You will not lose the 60/40 tax benefit with this entity.

  9. I don't think making a profit is a requirement for running a business and deducting expenses. Many startup companies lose money in the first few years. Trading is the same. And in trading, sometimes one can have a losing year dispite of many years of profitability.

    The expense deduction can offset some of the ordinary income from W2 and other income sources (such as interest/dividends).

    Of course if you have losses year after year after year on the same business, IRS will eventually ask you why you still stay "in business".
  10. heech


    As would my wife!
    #10     Oct 15, 2009