Filing tax return as Trader Status and Mark to Market Election

Bolimomo · Apr 6, 2009

Should you report your tax return as a "trader"? That's what I and probably many other traders would like to know.

I found the following web page that I think has very good information on filing your return as trader status:

http://www.fairmark.com/traders/intro.htm

11 pages. Go through them. Very informative I think. It also has references to the IRS's publications on trader taxation.

Do you qualify to be considered a "trader" in the eyes of IRS?

As a trader, you would have the benefit of deducting many more expenses than if you are an investor, and not subject to the 2% floor in Schedule A. And they said (seems rather strange but it is the way you do it):

- File Schedule C to claim all the business expenses. But leave the income as 0. This will show your business has a loss, which will offset your ordinary income, and since you have no income from your Schedule C, you don't need to pay self-employment tax. Only if you elect not to have the "Mark to Market" election. If you elect "Mark to Market", your trading gain will be treated as ordinary income.

- File all your trading gains in Schedule D as capital gain.

Free Thinker · Apr 6, 2009

Quote from Bolimomo:

Should you report your tax return as a "trader"? That's what I and probably many other traders would like to know.

I found the following web page that I think has very good information on filing your return as trader status:

http://www.fairmark.com/traders/intro.htm

11 pages. Go through them. Very informative I think. It also has references to the IRS's publications on trader taxation.

Do you qualify to be considered a "trader" in the eyes of IRS?

As a trader, you would have the benefit of deducting many more expenses than if you are an investor, and not subject to the 2% floor in Schedule A. And they said (seems rather strange but it is the way you do it):

- File Schedule C to claim all the business expenses. But leave the income as 0. This will show your business has a loss, which will offset your ordinary income, and since you have no income from your Schedule C, you don't need to pay self-employment tax. Only if you elect not to have the "Mark to Market" election. If you elect "Mark to Market", your trading gain will be treated as ordinary income.

- File all your trading gains in Schedule D as capital gain.
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you cant make that decision now for 2008 taxes. you had to declare trader status a year ahead.

Bolimomo · Apr 6, 2009

Quote from vhehn:

you cant make that decision now for 2008 taxes. you had to declare trader status a year ahead.
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Where and how do you declare trader status?

Surdo · Apr 6, 2009

Quote from Bolimomo:

Where and how do you declare trader status?
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You must file IRS form 3115 "Application for Change in Accounting Method" prior to April 15th, 2009 in order to file your 2009 return as MTM next year.

Bolimomo · Apr 6, 2009

Quote from Surdo:

You must file IRS form 3115 "Application for Change in Accounting Method" prior to April 15th, 2009 in order to file your 2009 return as MTM next year.
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I don't think that is what we are talking about here. Form 3115 is for application for change in accounting method.

The web page that I referenced specifically said if you file as a trader but NOT electing for "Mark To Market", you report the expenses in Schedule C and the trading gain in Schedule D.

I don't want to elect for "Mark To Market". I don't hold stocks overnight (I am a day trader), let alone over the tax year. Everything for me is already mark to market.

I am just not clear if there is a special form that needs to be filled out to be in a trader status.

Could it be that what you and vhehn are talking about is the "Mark To Market" election.

Surdo · Apr 6, 2009

Quote from Bolimomo:

I don't think that is what we are talking about here. Form 3115 is for application for change in accounting method.

The web page that I referenced specifically said if you file as a trader but NOT electing for "Mark To Market", you report the expenses in Schedule C and the trading gain in Schedule D.

I don't want to elect for "Mark To Market". I don't hold stocks overnight (I am a day trader), let alone over the tax year. Everything for me is already mark to market.

I am just not clear if there is a special form that needs to be filled out to be in a trader status.

I think what you and vhehn are talking about is the "Mark To Market" election.
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Trader status requires filing for MTM status!

You need to hire a CPA or do some reading.

gkishot · Apr 6, 2009

Quote from Surdo:

Trader status requires filing for MTM status!

You need to hire a CPA or do some reading.
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Why is it a requirement? One is type of business, another one is type of accounting.

Bolimomo · Apr 6, 2009

Quote from Surdo:

Trader status requires filing for MTM status!

You need to hire a CPA or do some reading.
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From what I have read and my conversations with my trader accounting firm: filing with trader status and electing for "Mark To Market" are two different things.

Here is one of such pages you can read on the Internet:

http://www.traderstatus.com/trader.htm

And I quote them:

For IRS tax purposes a Trader might operate as a "trade or business" if the intent is to profit from market price swings as the primary source of income for the year. With this as the intent, then once the taxpayer's activity rises to a sufficient level it may be taxed under trader status rather than, by default, as an investor (investor status).

For the trade or business to gain Securities Trader Status or Commodities Trader Status with the IRS it might buy and sell Stocks, Stock options, Bonds, Futures, Commodities, E-mini's, QQQQ options, Â§1256 contracts, foreign currency contracts and so on.

Generally speaking to have Trader Status your activity must be substantial. and you must carry on the activity with continuity and regularity.

Per an IRS audit/examination guide, you must not have any interest in "capital appreciation" or even in "conservation of capital." While it is true that generally a knowledgeable business person should probably have money management as a major concern, it is a fact that IRS agents have these instructions in their audit guides.

Avoid tax return preparation "errors" that the IRS is wise to. Some preparation firms make extra money handling the IRS inquiries and examinations resulting from such "unintentional" oversights. We feel that it is best to do it right the first time and avoid questions from the IRS.

Beware of these common misconceptions:
Please note that obtaining "trader status" alone results in no change from the norm for reporting your gains and losses - which is to say, they remain Schedule D capital gains and losses. If you wish to obtain Form 4797 ordinary gains and losses you must further elect "mark-to-market" under stringent rules.

Please note further that once obtaining "trader status" with or without having elected "mark-to-market" that the security trades must still be accounted for by matching purchases and sales on a FIFO basis (unless "versus purchase" is stated at the time of sale) and listing "each" "matched" "transaction" in a format similar to what is found on IRS Schedule D. This reporting format does not change whether the trader is an individual person, a LLC, or a corporation.
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Whether or not you are a trader needs to be manifested by your trading activities. You can't just file a form and claim that you are a "trader", and only transact 3 times a year with a substantially long holding period for example.

professorkev · Apr 6, 2009

I did 650 TRADES LAST YEAR, about 6 million dollars worth of trades and made profit. use it as my majority income and 2 days a week.

I wonder if this would still qualify me? I believe most day trader "Status" people probably do 40-50 tradews a week?

Bolimomo · Apr 7, 2009

Quote from professorkev:

I did 650 TRADES LAST YEAR, about 6 million dollars worth of trades and made profit. use it as my majority income and 2 days a week.

I wonder if this would still qualify me? I believe most day trader "Status" people probably do 40-50 tradews a week?
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I am not sure if anybody can advice (without consequences) you whether you have trader status. Take a look at this page and decide for yourself:

http://www.fairmark.com/traders/defined.htm

Basically there are 2 tests. And I quote:

Definition of "Trader"

The definition has evolved from court rulings.

There is no definition of trader in the Internal Revenue Code or in the regulations. Instead, the definition has evolved through a number of court cases over the years. Under the definition that has evolved, you have to satisfy the following two tests to be a trader:

Trading Activity Test

The first test distinguishes between the activity of investing and the activity of trading. Your activity is investing if it's designed to benefit from long-term appreciation in securities, or to produce a significant amount of dividend or interest income. Investors are likely to be interested in a company's balance sheet, market share, industry trends and other indicators of long-term viability. They typically ignore short-term price fluctuations â or try to, anyway.

Trading activity, for purposes of this test, consists of trying to capture short-term price swings. Many traders have little interest in the long-term prospects of the companies they trade. They may know little about the company other than the way the price of its stock has moved in the recent past. If a trader happens to capture a dividend, that's likely to be merely coincidental. Traders seek their profits in the market's zigs and zags.

The precise limits of this test have never been established. It's reasonably clear that you don't have to be a day trader to be a trader. People who hold positions overnight, or for a few days at a time, are still engaged in trading activity. The point where your average holding period indicates you're an investor rather than a trader is almost surely more than a few days, and probably less than six months. There isn't a lot to go on if you're looking for a more refined answer than that. If your typical holding period is 60 days, you're in no man's land.

Substantial Activity Test

Even if you engage in trading activity, you have to do enough of it, regularly enough, over a long enough period of time, to be considered a trader. I call this the substantial activity test.

Different words have been used to express this test. The Supreme Court said the taxpayer must be "involved in the activity with continuity and regularity." The Tax Court has used the words "frequent, regular and continuous." The basic point is that you aren't a trader unless you do a lot of trading, and keep at it on a regular basis over an extended period of time.

Here again there is no bright line. Are 10 trades a week enough? 20? No one can say for certain. My feeling about the way the courts should decide the question is to look at whether the activity was carried on the way someone would if they treated it as a serious business. If you have a good business reason for executing only a few trades, or none at all, for a period of time, then your absence from the market should not disqualify you from trader status. But if your spotty trading activity, or low volume, indicates a lack of commitment to trading as a business, then you aren't a trader. It remains to be seen whether the courts will take the approach I advocate.

Both Are Required

You need to pass both tests to be a trader. There are cases where the taxpayer was not a trader even though his activity was substantial, because the activity was investing. And there are cases where the taxpayer was not a trader because he failed the substantial activity test, even though his activity was trading, not investing. If you fail either test, you are not a trader, do not pass "Go," do not collect $200.
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