A day trader employs the rise and fall of stock prices, hoping that it will result in net profit over a year. This means there will be a tax on the proceeds.
There are, however, some strategies a day trader can use to save on their profits:
Deduction from Trading Expense
If according to Uncle Sam, you are a day trader, there is a provision to make deductions for business expenses when filing taxes. Examples of the deduction parameters are home office, office space, cost of accounting, equipment costs, cost of software, etc. Like any business, when you write off these expenses, it helps reduce your tax burden.
Some businesses might not need much equipment, even though this does not really apply to a day trader. The software for analyzing the market involves subscriptions, which might cost $20 per month. Veteran traders who prefer to build their own software might need up to six figures for the entire process. A day trader will be able to write this off for a couple of years.
Mark-to-Market Accounting
There is a tax filing selection, which is known as mark to market accounting. This means that the taxpayer will report their total annual losses and gains like they sold it all on the year's final day. Uncle Sam can account for net losses against the income using unlimited bases, not like the 3000 USD limit for ordinary taxpayers.
The income from your day trading activities will be classified with the tax rate of capital gains (short term). Every couple of years, these figures change based on the political landscape. The idea is for this approach to make one income similar to what happens with ordinary income, the same thing as an employed individual.
The self-employment tax rate is currently about 15.3%. Many stock investors need their traders to pay a higher tax than what they will pay if self-employed. Many people also believe that the financial opportunity that comes from day trading is way more than what comes from self-employment. As a result, paying a tax of 24% from six figures is better than paying 15% self-employment tax on half that amount.
Tax Loss Harvesting
An idea of what a wash sale is is essential in understanding this point. The wash sale involves selling stock and losing, and buying the same stock in a short while. According to Uncle Sam, the “short time” is defined as 30 days. Also, the security repurchased should be very similar, not necessarily the same. With this rule, retail investors cannot sell their security for a loss and buy it again. This rule, however, does not apply to day traders as specified by Uncle Sam.
It seems counterproductive why anyone would make a loss from the sale of stock. The idea is to make the loss bring down their adjusted Gross Income. Besides, the fact that they will buy it later makes it have little effect on their long term capital gain.
This is, however, an illegal endeavor for an average investor not classified as a day trader.
This rule does not bound day traders as specified above. This is a perfect and legal tax strategy if a day trader wishes to sell some part of their stock for a loss to help them claim a bigger loss on their tax return, which will reduce the entire tax burden.
A day trader that is also involved in options trading, alongside trading of stock, needs to check for more information about sales taxes of stock options.
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