I have just started daytrading (and actually making a little money at it). Can this activity be set up as a "business" and therefore incur normal tax rates as opposed to capital gains--and also of course write-off any losses. Any help/advice would be appreciated. I am a real infant when it comes to taxes associated with day trading. Thanks
This question invokes a lot of issues, any one of which could be the subject of a book or seminar on its own. First, it is possible for a daytrader to achieve "business" status. There is a significant body of caselaw that establishes the distinction between a "trader" [who the IRS will recognize as being in the business of trading stocks, options, or whatever] vs. an "investor" [who does not carry on the activity to the level of a business]. At the risk of oversimplification, a trader is one who trades on a frequent and regular basis, to catch short-term market swings, does the trading himself (i.e., no money manager present), and ideally, obtains the majority of his livelihood through trading. There are other factors involved as well, but no one factor is determinative. As to the ordinary income vs. capital gains issue, if one can qualify as a trader, then one has the opportunity to elect mark-to-market (MTM) accounting under Section 475 of the Internal Revenue Code. If the election is made, then there are several results. First, the character of gain/loss is changed from capital gain/loss to ordinary income/loss. Second, the trader's positions are deemed sold at the end of the year ("marked to market") and all resulting gain or loss is recognized. Stated differently, the positions are constructively sold, and the trader's basis in those positions is adjusted accordingly. Third, the wash sale rule does not apply to a trader who has elected MTM. There are some significant considerations that need to be taken into account before making the MTM election, however. The election is irrevocable without the consent of the IRS Commissioner. Second, the election is not recommended for anyone who is going to be trading Section 1256 contracts, since those contracts are taxed at 60% long term capital gains (i.e., a maximum of 15% now!) and 40% short term capital gains rates (i.e., the ordinary income rate). The 60% LTCG rate will not be available if the MTM election is made since all income thereafter will be ordinary. Each of the points mentioned above just begins to scratch the surface. Trader taxation is complex and involved. You are not going to get all the information you need in one chat room blurb. You are just starting to explore the issues involved. I recommend you spend some time viewing the background information on our website, www.tradersaccounting.com, plus I think Robert Green has good background information on his website as well at www.greencompany.com. After you've reviewed all this background information, you'll be ready to ask some more focused questions. Good luck on your journey!