It just came to me that there are unknowns to myself out there in this world that can make me broke. I don't know what these unknowns are. But I can give you an obvious example of such unknown in tax law (to some people, not me) so that you understand what I am talking about and help me to find more such unknowns. A dude traded frequently but had no idea of certain details in the tax law. So he thought that he ended up the year with a total short term gain +0.5M (1M gain and 0.5M loss, all short term). However, since he did not claim trader status and is unable to claim almost any loss due to wash sale that restrict him in some not obvious strange way. Anyway, now IRS wants tax from him. He can do nothing but go file personal bankruptcy. This example may not be realistic. But what I mean here is that there are some unknowns in tax laws, exchange/broker rules, or elsewhere that can broke you and me because we trade and trade too much. Can you give me more examples, please?
1. He would have tax due on the .5M gain, no matter what. 2. If he doesn't know about wash sale, he should have an accountant do his capital gain reporting. "Wash Sale" losses are not deductible, but such losses are added to the cost basis of the next trade in the same security and therefore carried forward. Accounting for them is a pain in the neck, but they actually have no overall financial impact. Don't worry about hidden rules that can cause you to go broke if you've traded profitably. (The Gummint has LOTS of plans confiscate all of your wealth, but this isn't one of them.)
Is that a hypothetical example? I have never heard of the IRS going after someone because of failure to observe the "wash sale" rule. Fact is, a great majority of traders do not follow that rule. Call it gambling, but again I have never heard of one case of the IRS going after someone because of it. Anyone?
Neither have I. Nor should we. If the IRS came after someone for that, all they'd have to do is calculate the losses and cost basis correctly and the problem would go away. The worst that could come out of such an exercise is the IRS collected a bit of tax this year in exchange for an effective loss carry-forward next year. I'm sure that's why the IRS doesn't challenge this. The Wash Sale rule is antequated, stupid, and has zero overall financial impact (save what somebody might pay an accountant to figure 'em). It sould be repealed like the old "short-short" rules.
Don't remember the exact percentage, but it went something like this: "If a mutual fund has more than 30% (?) of its gains from positions held less than 90 days, the fund is subject to losing its pass-through conduit status". Meaning, the fund's gains could first be taxed like a corporation rather than the required pass-through of 95% of all gains an losses. Funds that did any kind of trading used to jump thorugh all kinds of hoops every year to stay on the right side of the percentage. Fortunately, somebody woke up and recognized the stupidity of that law and repealed it... early '90s, if I recall. Rydex, ProFunds, and Potomac couldn't be in business without that law being repealed.
I interpreted the situation as the following: the dude had losses of 0.5M and gains of 1M. Suppose the 0.5M in losses could not be taken because of the wash sale rule and had to be transferred into the dude's next tax year. Now his income to the IRS in this tax year is 1M so he has to pay like 0.4M to the government and state. Suppose he used up 0.2M during the year (to buy a house, a car, and to pay for numerous parties) - now he doesn't have enough money to pay for his taxes this year. Furthermore, suppose he goes on a cold streak and decides he isn't cut out for the trading lifestyle - then he can only take $3k per year in capital loss carryover (out of the 0.5M in losses). Therefore, he no longer has any money (bankrupt) but yet he has 0.5M in capital losses that he can take at a rate of $3k/year. In a sense, he shouldn't be bankrupt, but he is. The point is you can get screwed on these tax laws and the IRS can nail you on it. There can be financial impact if you don't understand the tax law.
What? You want to be a writer for the Twilight Zone when you grow up? How could anyone string together so many losers to get nailed by wash sales and yet be savvy enough to have 1M in gains? OK, OK... In Rod Serling world, the poor bum trades the NQ like a deamon and racks up 1M in gains. But EVERY damn time he trades the emini, he loses and loses so that he can't offset the losses. (Oh and buy the way, he's so dumb he doesn't realize all he has to do is stop trading his losing contract by Nov 30 and all the wash sales become usable.) Yeah, it could happen.... NOT!!
Yes, the example I gave was far-fetched. However, I'm sure the IRS has caught people on the wash sale rule before. And I'm sure that people, who didn't know any better, were put into financial difficulty because their capital losses were delayed into the next tax year (by the wash sale law).