Trader Tax Services and Accounting
A specialization of our firm is meeting the accounting and tax compliance needs of traders. We handle
tax planning and preparation, entity formations, retirement-plan services, and IRS/state tax exam representation services,audit services, third party administration and specialized trading software.
There are other CPAs who manage their firms in remote locations and employ staff in a virtual office environment where the client rarely if ever meets the person providing them advice. They typically have no personal experience in the trading world and employ tactics which can raise red flags. When you engage us, you get Eric Ross personally, not a recent hire handling your accounting.
Trader tax status is a special area in the tax law that provides for rules that allow a trader who meets defined criteria to treat the trading activity as a business. Ordinarily, people who invest in the markets are not considered in a trade or business thereby denying them the tax benefits of someone who trades for a living. Stemming from recent tax case law,there are a number of factors which generally indicate whether a person is conducting a trading business rather than just acting in the capacity of an investor. The same factors pertain to equities, ETFs, options, futures or forex and digital currency such as Bitcoin.
The right questions.The right answers.©
Investor or Trader?
“Investors” typically buy and sell securities and expect income from dividends, interest, or capital appreciation. They buy and sell these items and hold them for personal investment; they are not conducting a trade or business. Most investors are individuals. Sales of these securities result in capital gains and losses that must be reported on Form 1040, Schedule D (PDF), Capital Gains and Losses and on Form 8949 (PDF), Sales and Other Dispositions of Capital Assets, as appropriate. Investors are subject to the capital loss limitations in addition to the wash sales rules. Investors can generally deduct the expenses of producing taxable investment income. These include expenses for investment counseling and advice, legal and accounting fees, and investment newsletters.
Special rules apply if you are a trader in securities, in the business of buying and selling securities for your own account. This is considered a business, even though you do not maintain an inventory and do not have clients. To be engaged in business as a trader in securities, you must meet all of the following conditions:
The following facts and circumstances should be considered in determining if your activity is a securities trading business:
If the nature of your trading activities does not qualify as a business, you are considered an investor, and not a trader. It does not matter whether you call yourself a trader or a “day trader,” you are an investor. As with dealers, a taxpayer may be a trader in some securities and may hold other securities for investment. The special rules for traders do not apply to the securities held for investment. A trader must keep detailed records to distinguish the securities held for investment from the securities in the trading business. The securities held for investment must be identified as such in the trader's records on the day he or she acquires them (for example, by holding them in a separate brokerage account).
Traders report their business expenses on Schedule C. The Schedule A limitations on investment interest expense, which applies to investors, does not apply to interest paid or incurred in a trading business.
In addition to the deduction of their business expenses on Schedule C, traders are entitled to an additional option not extended to investors, the usage of the mark-to-market election. The tax treatment of sales of securities held in connection with a trading business depends on whether a trader has previously made an election under section 475(f) to use the mark-to-market method of accounting. If the mark-to-market election was not made, then the gains and losses from sales of securities are treated as capital gains and losses that must be reported on Schedule D . When reporting on Schedule D, both the limitations on capital losses and the wash sales rules continue to apply. However, if the mark-to-market election was timely made, then the gains and losses from sales of securities are treated as ordinary gains and losses (except for securities held for investment - see above) that must be reported on Part II of Form 4797 . Further, neither the limitations on capital losses nor the wash sale rules apply to traders using the mark-to-market method of accounting.
The Mark-to-Market Election
In general, the mark-to-market election must be made by the due date (not including extensions) of the tax return for the year prior to the year for which the election becomes effective. The election is made by attaching a statement either to your income tax return or to a request for an extension of time to file your return. The statement should include the following information:
If you have made a valid election under section 475(f), the only way to stop using mark-to-market accounting for securities is to request and receive written permission from the Service to revoke the election. Non-filing of the Form 3115 mentioned above will not invalidate a timely and valid election. To request permission to revoke your election under section 475(f), you must file a second Form 3115 and pay a fee.
If you qualify as being in the trading business you can report your trading expenses as business expenses on Schedule C (Business Profit or Loss). This is very beneficial, because your trading expenses are treated as ordinary expenses and they can be offset against all other taxable income.. Additionally, if you have a net trading business loss in excess of your other income, you may have a Net Operating Loss (NOL), which can be carried back two years or carried forward. Trading expenses include your margin interest which is not subject to the investment interest limitations. The important thing to remember is that even though you may miss the mark-to-market election, you may use business expenses on your tax returns. Our firm can also prepare these tax returns.
A qualifying trader may elect to use mark-to-market accounting (MTM) by April 15 of the current tax year. As an example, if you wanted to use MTM for tax year 2022 you needed to elect MTM by April 15, 2022 . If you did not elect MTM, then you may not use MTM and all trading gains and losses are treated as capital gains and losses plus you are subject to the wash sale rules . MTM converts capital gains and losses to ordinary gains and losses, so there is no limit on the amount of losses that can be deducted (there is a $3,000 limit on capital losses). MTM traders are also exempt from wash sale rules. If you tried to elect MTM on time but did not do so because you got bad advice from your accountant, or you have some other reasonable excuse, contact us. expense" limitations as it is for investors, and you can deduct many types of trading business expenses. Even if you have no taxable income, it pays to file your tax return with trader tax status, since your trading business expenses will translate into a Net Operating Loss. That can be carried back or forward, generating large tax refunds.
Taxation of Short Sales A short sale occurs when a trader borrows stock from his broker and sells it, hoping to profit by buying it back at a lower price. Short sales are a means to profit from market downturns or to hedge a position. Although a short sale is somewhat the reverse of buying a stock with the hope of profiting from an increase in stock price, the tax rules that apply to short sales are significantly different than those that apply to a long position.Tax law treats covered short sales differently from uncovered short sales. A covered short sale is one in which the taxpayer owns substantially identical securities, which includes not only the stock itself, but also any call or put options in which the stock is the underlying asset, or any other security that can be converted into the stock, such as convertible bonds, or any other property that would hedge the taxpayer's stock position, such as a futures or forward contract. A taxpayer is also considered to hold a substantially similar position in the stock if a spouse or closely related relative or even a closely held corporation in which the taxpayer is a major stockholder also owns substantially identical securities. An uncovered short sale is one that is not covered as defined above.An uncovered short sale gain or loss is always short term, because the holding period is deemed to begin when the stock is purchased that is used to close out the short sale. Since the short seller can only profit by buying at a lower price, he will wait until the day that he decides to close out the transaction to buy the stock, for it makes no sense to buy the stock back any sooner than that, since if the short seller believes that the price will go lower, he will wait until he thinks the price has reached its lowest point, then buy back the shares and close the short sale.