That's the way I always understood it. Got 3 things going on here. One is talking about trader status, one is talking about entities and one is talking about emotions.
Unfortunately for you it's not...Here it is from Green Trader Tax... Words of caution on TTS Many IRS and state agents don’t understand or respect individuals pursuing qualification as a trading business. While there is no bright line test for TTS, recent trader taxcourtcases better defined the volume of total trades required (720 per year per Poppecourt), frequency of trades (3-4 days per week) and average holding period (under 31 days per Endicottcourt). Once an exam starts, it can snowball into other issues. IRS and some state agents often want to challenge TTS if the trader is not a full-time, extremely active trader. And the IRS or state agent can ask about TTS and other issues for the years before and after the tax year examined. Learn tips for dealing with the IRS and states in Chapter 10. In the past, too manytradersbrought weak cases to taxcourtand have failed to defend themselves properly. That was certainly the case again recently with Poppe, Assaderaghi, Nelson and Endicott. Serving up easy wins in exams, appeals, private letter rulings and taxcourtencourages the IRS and states to further question businesstradersbased on bad legal precedent. When TTS is too difficult to achieve, consider the alternative strategies discussed in Chapter 9. It’s also very important to have good CPAs and tax attorneys who are experts in trader tax law in your corner. Watch out for bad tax advice: Over the years, other service providers suggestedtraderscould easily deduct pre-business education expenses using C-Corps. This advice is very wrong. We cover what’s allowed and what’s not in Chapter 5. https://greentradertax.com/greens-2016-trader-tax-guide/
there is no specified rules according to IRS, I agree with you on that. Prior court cases have made some interpretations.
Earned income is required to fund most types of retirement accounts. If you form an entity for trading, and you and/or your entity does not qualify for trader tax status, capital gains from trading will be passed through as capital gains on a K1, which is not earned income.Nopw there are exceptions, but we are talking about trading for a living, not a hedge fund, not a portfolio manager, or other things, just trading for a living. Trader tax status is what allows for the earned income necessary to fund most types of retirement accounts. Applies to sole prop, Schedule-C traders too. In that case, the trader must have trader tax status to successfully use specific techniques converting schedule c business income(cap gains) into earned income. By the way, no formal entity need be created for Schedule-C traders, individual or a de facto partnership... optics suck, done that way, imo. But the point is, "forming an entity" as you said, is not the key, earned income is.
Strange as it may seem, the IRS Code does not define who or what a securities trader is (but starting in 2000 the IRS form 1040 instructions do). To further guide us there are a number of Tax Court decisions which decided whether a taxpayer's transactions in securities constituted a bona-fide trade or business. In (Comr. v Groetzinger 1987), the Supreme Court concluded "to be engaged in a trade or business, the taxpayer must be involved in the activity with continuity and regularity and that the taxpayer's primary purpose in engaging in the activity must be for income or profit." This landmark decision confirmed the availability of trader status for income tax purposes. (IRS Code §162(a) and §62(a)(1)). Example: An individual's trader status was approved where his entire income was derived from his securities trading (a good argument for setting up your own pure-play trading entity), he devoted his whole working day to his stock transactions (having W-2 wage employment is not helpful here, again an argument for establishing an entity), and judgments regarding purchases and sales were made directly by him, based on his personal investigation of the assets, operation, and management of various corporations. In addition, the sheer quantity of transactions he conducted supported a reasonable conclusion that his business was trading on his own account. In the year in question, he conducted 332 transactions representing the transfer of 112,400 shares with a total value of over $3,000,000. Furthermore, it was his practice to buy to the maximum extent of allowable margin. (Levin, Samuel) To substantiate your stock, option and futures trading activity, it is a good idea each day for some traders to print out their activity, including the unexecuted limit orders. This can then be given to IRS in the case of an audit. These print-outs will show more activity than mere executed orders that are reported on Schedule D, form 6781 and form 4797. "Investors trade solely for their own account and do not carry on a trade or business. Their securities sales result in capital gain or loss and their deductible expenses are itemized deductions. Dealers sell securities to customers in the ordinary course of trade or business. Their sales result in ordinary gain or loss and their deductible expenses are trade or business expenses. Traders buy and sell securities frequently but have no customers. Their purchases and sales result in capital gain and loss, and their deductible expenses are trade or business expenses." "Even if you engage in extensive securities activities, you are an investor, not a dealer or trader, if you do not seek profit primarily in swings in daily market movements, and do not personally engage in or direct the purchases or sales. An investor trades for profit-motivated reasons such as long-term appreciation, dividends and interest. Whether the activities of an individual constitute trade or business or investment is determined from the facts in each case. These distinctions have been established through court cases."