How To Qualify For Trader Tax Status For Huge Savings Robert A. Green, CPA Contributor Great Speculations Contributor Group Markets Leading writer and speaker in the area of trader tax benefits. Traders work on the floor of the New York Stock Exchange in New York, Monday, Dec. 24, 2018. (AP Photo/Seth Wenig)ASSOCIATED PRESS Trader tax status (TTS) constitutes business expense treatment and unlocks an assortment of meaningful tax benefits for active traders who qualify. The first step is to determine eligibility. If you do qualify for TTS, you can claim some tax breaks such as business expense treatment after the fact and elect and set up other breaks — like Section 475 MTM and employee-benefit plans — on a timely basis. Section 475 gives a TTS trader “tax loss insurance,” exemption from wash sale loss adjustments on securities and ordinary loss treatment, avoiding the capital loss limitation. It also makes the trader eligible for the new 20% qualified business income (QBI) deduction. QBI includes 475 ordinary income but excludes capital gains. Trading is a specified service activity with an income cap for the QBI deduction. There’s no election for TTS There’s no election for TTS; it’s an optional tax status based on facts and circumstances only. A trader may qualify for TTS one year but not the next. TTS qualification can be for part of a year, as well. Perhaps a taxpayer qualified for TTS in 2017 and quit or suspended active trading on June 30, 2018. Include the period of qualification on Schedule C or the pass-through entity tax return and deduct business expenses for the partial-year period. If elected, use Section 475 for trades made during the TTS period, too. Business expense treatment Qualifying for TTS means a trader can use business treatment for trading expenses. TTS is also a precondition for electing Section 475 MTM ordinary gain and business loss treatment. YOU MAY ALSO LIKE Business expense treatment under Section 162 allows for full ordinary deductions, including home-office, education, Section 195 start-up expenses, Section 248 organization expenses, margin interest, tangible property expense, Section 179 (100%) depreciation, amortization on software, seminars, market data, stock borrow fees, and much more. As an example of the potential savings, if TTS business expenses and home office deductions are $20,000, and the taxpayer’s federal and state tax bracket is 35%, then income tax savings is about $7,000. TCJA suspended “certain (all) miscellaneous itemized deductions subject to the 2% floor,” including investment fees and expenses, commencing in 2018. The only remaining itemized deductions for investors are investment-interest expenses, which are limited to investment income, and stock borrow fees deducted as “other itemized deductions.” TCJA gives more incentive for traders to try to qualify for TTS. How to qualify It’s not easy to qualify for TTS. Currently, there’s no statutory law with objective tests for eligibility. Subjective case law applies. Leading tax publishers have interpreted case law to show a two-part test to qualify for TTS: Taxpayers’ trading activity must be substantial, regular, frequent, and continuous. The taxpayer must seek to catch swings in daily market movements and profit from these short-term changes rather than profiting from the long-term holding of investments. IRS agents often refer to Chapter 4 in IRS Publication 550, “Special Rules for Traders.” Here’s an excerpt: The following facts and circumstances should be considered in determining if your activity is a securities trading business. Typical holding periods for securities bought and sold. The frequency and dollar amount of your trades during the year. The extent to which you pursue the activity to produce income for a livelihood. The amount of time you devote to the activity. The words “substantial, regular, frequent, and continuous” are robust terms, yet case law doesn’t give a bright-line test with exact numbers. The publication mentions holding period, frequency, and dollar amount of trades, as well as time devoted by the taxpayer. It also says the intention to make a livelihood, an essential element in defeating the hobby-loss rules. Trading is not personal or recreational, which are the key terms used in hobby-loss case law. Golden Rules We base our golden rules on trader tax court cases and our vast experience with IRS and state controversy for traders. The trader: Trades full time or part time, for a good portion of the day, almost every day the markets are open. Part-time and money-losing traders face more IRS scrutiny, and individuals face more scrutiny than entity traders. Hours:Spends more than four hours per day, almost every market day working on his trading business. All-time in the trading activity counts, including execution of trade orders, research, administration, accounting, education, travel, meetings, and more. Few sporadic lapses:Has infrequent lapses in the trading business during the year. Traders can take vacations, sick time, and personal time off just like everyone else. Frequency:Executes trades on close to four days per week, every week. Recent tax-court cases show that to help prevent IRS challenge of a TTS claim; it is wise to trade close to four days per week or 75% of available trading days — even if this requires the taxpayer to make smaller trades with reduced risk on otherwise non-trading days. Volume:Makes 720 total trades per year (Poppe court) on an annualized basis. The buy and sell count as two total trades. The court mentioned Poppe having 60 trades per month. During the year, it’s crucial to consider the volume of trades daily. We recommend 720 trades per year — about four trades per day, four days per week, 16 trades per week, and 60 trades a month. The markets are open approximately 250 days, and with personal days and holidays, you might be able to trade on 240 days. A 75% frequency equals 180 days per year, so 720 total trades divided by 180 trading days equals four trades per day. Holding period:Makes mostly day trades or swing trades. The IRS stated that the holding period is the most critical factor, and in the Endicott court, the IRS said average holding period must be 31 days or less. That’s a bright-line test. Intention:Has the intention to run a business and make a living. Traders must have the intention to run a separate trading business — trading his or her own money — but it doesn’t have to be one’s exclusive or primary means of making a living. The key word is “a” living, which means it can be a supplemental living. Operations:Has significant business equipment, education, business services, and a home office. Most business traders have multiple monitors, computers, mobile devices, cloud services, trading services, and subscriptions, education expenses, high-speed broadband, wireless, and a home office. Account size:Has a material account size. Securities traders need to have $25,000 on deposit with a U.S.-based broker to achieve “pattern day trader” (PDT) status. We like to see more than $15,000 for trading other financial instruments. What doesn’t qualify? Don’t count these three types of trading activity for TTS qualification: Automated trading without much involvement by the trader (but a trader creating his or her program qualifies); engaging a professional outside investment manager; and trading in retirement funds. Do not include these trades in the golden rule calculations. 1. Automated trading.An entirely canned automated trading service — sometimes referred to as an “expert adviser” program in the forex area — with little to no involvement by the trader doesn’t help TTS; in fact, it can undermine it. The IRS may view this type of automated trading service the same as a trader who uses a broker to make most buy and sell decisions and executions. On the other hand, if the trader can show he’s very involved with the automated trading program or service — perhaps by writing the code or algorithms, setting the entry and exit signals, and turning over only execution to the program — the IRS may not count the automated trading activity against the trader. Some traders use a “trade copying” service and copy close to 100% of the trades. Trade copying can be similar to using a canned automated service or outside adviser, where the copycat trader does not qualify for TTS on those trades. 2. Engaging a money manager.Hiring a registered investment adviser (RIA) or commodity trading adviser (CTA) — whether they are duly registered or exempt from registration — to trade one’s account doesn’t count toward TTS qualification. 3. Trading retirement funds. Achieve TTS through trading taxable accounts. Trading activity in non-taxable retirement accounts doesn’t count for purposes of TTS qualification. For more in-depth information on trader tax status, seeGreen’s 2019 Trader Tax Guide. Robert A. Green, CPA GreenTraderTax Author of Green’s 2019 Trader Tax Guide Managing Member, Green, Neuschwander & Manning, LLC Robert A. Green, CPA Contributor Robert A. Green is a CPA and founder and CEO of Green & Company Inc. (GreenTraderTax.com), a publishing company, and Managing Member and Founder of Green, Neuschwander & Manning, LLC, a tax and accounting firm catering to traders, investment management, and small business. He is a leading authority on trader tax. Mr. Green is a contributor to Forbes. He is also the author of The Tax Guide for Traders (McGraw-Hill, 2004), Green’s 2018 Trader Tax Guide and wrote the “Business of Trading” column for Active Trader magazine for 14 years. Mr. Green is frequently interviewed and has appeared in the New York Times, Wall Street Journal, Forbes, and Barron’s. Mr. Green has also appeared on CNBC, Bloomberg Television, and Forbes.com Video Network. He is the chief tax speaker at the MoneyShow University and Traders Expo and teaches “Trader Tax 101″ for CCH to tax professionals. https://www.forbes.com/sites/greats...der-tax-status-for-huge-savings/#16d6c6cc1a0a
I see the minimum number of trades per year went up. It used to be 500 per year. The tax regulations are so vague, it's a crap shoot. So one has to follow the tax court cases. Fortunately Green does that for us. I have used him for years.
If the above is your take-away from the "how to qualify" + "golden rules" + "what doesn't qualify" sections in the article.... NO!
Can’t you form a business entity like an LLC and use it to trade? Then the entity is your business and it can write off expenses.
Yes. The entity should be devoted solely to trading, would make a timely filing for MTM, -and- need to qualify for TTS. An entity alone does not magically qualify for trading business treatment. Entity type is also important from a tax standpoint. For instance a C-corp does not benefit from 60/40 tax treatment of section 1256 contracts. An S-Corp must comply with all S-corp requirements, including "reasonable" (W2) wages, and an LLC must report capital gains/losses whether realized or not to members/owners.
I can have a FT job, but I will need to form an LLC(entity) and trade through that to get TTS tax advantages? My current taxable account is NOT under an LLC. So I need to create an LLC and open a new account or move my existing trading account into that LLC to qualify? Frequency and size of trades qualify. I basically daytrade every single day and the profits and losses are nontrivial. Sole purpose of this activity is to generate trading profits and nothing else.
I can have a FT job, but I will need to form an LLC(entity) and trade through that to get TTS tax advantages? My current taxable account is NOT under an LLC. So I need to create an LLC and open a new account or move my existing trading account into that LLC to qualify? Frequency and size of trades qualify. I basically daytrade every single day and the profits and losses are nontrivial. Sole purpose of this activity is to generate trading profits and nothing else.
1) An entity is a separate taxpayer! An entity needs to timely elect MTM AND qualify for TTS. 2) Yea, brokerage, bank, and other trading business accounts and assets need to be titled properly. 3) Generating trading profits is applicable to investors, hobbyists, non-trading businesses, and trading businesses. Being that is YOUR SOLE PURPOSE, the IRS may not view that as intent to operate a trading business with an intent to provide a primary or supplemental livelihood. I'm just a lowly full-time futures (day)trader who has operated through an S-corp for many years, doing my best to receive all the deductions, credits, and benefits I am legally eligible for given my business and personal structure, while paying my US tax obligations according to the rules set forth by the US-IRS. IOW, I know nothing. Seek professional advise for your plans and circumstances.