One good thing about trading is that all you have to do to become a trader is get started. Many people trade as a hobby, while others trade full-time for a living, and some traders fall somewhere along this spectrum with their businesses.
Depending on the volume and frequency of your trades, you may receive certain benefits at tax time. If you are a serious and dedicated day trader, claiming active trader tax status is the best option to maximize your deductions and minimize your losses. But how do you become eligible for this elite tax bracket?
To become eligible for active trader tax status, you must meet the following conditions in the eyes of the I.R.S.:
Seek profits from daily swings in prices of securities
Proponents of active tax trader status should aim to profit from short-term market movements rather than long-term holdings/investments. This criterion was established in Poppe v. Federal Commissioner of Revenue in 2015. The court ruled that William Poppe could claim tax trader status and associated benefits because his turnover (approximately 60 transactions per month) reflected an intention to profit from short-term price fluctuations.
Substantial, frequent, and continuous trade
To qualify as a full-time or part-time trader, you must spend at least four hours a day trading almost every market day. Time spent on research, performing related administrative tasks, and any travel for meetings or training counts towards this rate, in addition to time spent buying and selling trades, of course. You can take a few days off here and there like any job, but you can't take a few weeks or months off if you want to qualify.
Intention to make a living from trading activities
Trading does not have to be the only source of income to qualify for Active Trader status, but it must be significant. You must trade with the intention to trade as a business, to use your money as trading material, or to show that you are serious about trading. To verify, the I.R.S. may look for important business equipment, such as educational resources, software, and a dedicated office at home or elsewhere.
Other Types of Trader Tax Status
Traders who meet the above conditions can benefit from the tax status of active traders and benefit from favorable tax advantages. Additionally, active traders can qualify for client day trader status if they have a deposit of $25,000 with a U.S. broker. However, active trader status (ATT) is not the only way the I.R.S. classifies businesses.
Most traders have standard trader status, which means they do not have an established business identity and are considered "hobby traders." Defaulting traders cannot deduct trading fees or expenses directly related to their investing activities. The other status to which a trader can claim is the tax status of a self-employed trader. This status is generally ideal for incorporated traders or anyone who uses a cash account for their trading activities. Advantages include claiming additional itemized deductions and capturing the maximum share of your capital losses.
Trader tax status
Trader Tax Status (TTS) is a trading expense treatment that unlocks important tax benefits for eligible active traders. The first step is to determine eligibility. If you are eligible for TTS, you will be able to claim certain tax credits, such as after-tax treatment of business expenses, and you will be able to choose and implement other tax credits.
Business expenses include home office, education, start-up expenses, organizational expenses, margin interest, material expenses, Section 179 depreciation (100%) or 100% bonuses, software amortization, self-built automated trading systems, seminars, market data, stock loan rates, and more.
Securities dealers with TTS should consider electing ordinary treatment of gain or loss in a timely manner under Section 475. It is safe to call it tax loss insurance: it exempts securities transactions from loss-of-sale adjustments and the $3,000 limit on capital losses. Section 475 profitable traders can benefit from the 20% qualified business income (Q.B.I.) deduction, while the Q.B.I. excludes capital gains and losses.
A TTS S-Corp unlocks deductions for deductible health insurance premiums and pension plan contributions.
How to Apply for Trader Tax Status
The I.R.S. requires you to notify them before applying for active trader status. To do this, you must provide them with your previous year's tax return, Form 4868 (the Application for Automatic Extension of Time to File U.S. Individual Income Tax Return), and a written intention to make a market-to-market election under section 475(f) of the Internal Revenue Code (I.R.C.).
The process of being eligible for active trader tax status can be complicated. Your best chance of success is to hire a professional tax professional to help you.
FOR MORE INFORMATION ON HOW JIM McCLAFLIN, EA, NTPI FELLOW, CTRC CAN BEST HELP YOU WITH YOUR TAX FILING NEEDS, PLEASE CLlICK THE BLUE TAB ON THIS PAGE.
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Jim McClaflin, EA, NTPI Fellow, CTRC