I prompted Bing’s ChatGPT to write blog posts on “trader tax benefits” and “trader tax status.” See my comments in yellow highlight. I also used Grammarly. ChatGPT did a good job, but gave rudimentary advice. There are nuances in our content that ChatGPT missed. GreenTraderTax and my Forbes articles are a source for ChatGPT’s blog posts.
Trader Tax Benefits:
If you are an active trader buying and selling securities for a living, you may wonder how to save money on taxes. One way to do that is to qualify for trader tax status (TTS), which allows you to deduct various business expenses and take advantage of unique tax treatments. This blog post will explain TTS, its benefits, and how to qualify.
What is trader tax status?
Trader tax status is a designation that the IRS grants to certain traders who meet specific criteria. It is not an election you can make; you must prove (assess) that you are eligible based on your trading activity and intention. Trader tax status allows you to treat your trading income and expenses as a business rather than an investor. You can deduct your trading-related expenses on Schedule C, such as commissions (wrong), software, education, interest, and home office. (Deduct brokerage commissions from sales proceeds and add them to cost basis when reporting capital gains and losses or Section 475 income.)
You can also elect to use Section 475 mark-to-market accounting, which converts your capital gains and losses into ordinary income and losses. Section 475 can help you avoid the wash sale rule and the $3,000 capital loss limitation. Additionally, if you form an LLC or a corporation and elect S-corp status, you can deduct health insurance premiums and retirement plan contributions as employee benefits.
How to qualify for trader tax status?
The IRS does not have a clear-cut definition of trader tax status, but it does provide some guidelines based on court cases and rulings. Generally, you must meet the following requirements:
– You trade substantially, regularly, frequently, and continuously throughout the year. You have to meet no specific number of trades or hours, but the IRS expects you to trade almost every day that the market is open and execute hundreds of transactions per year.
– You seek to profit from short-term price swings of securities rather than dividends, interest, or long-term appreciation. You typically hold your positions for less than a day or a few days at most (an average holding period of fewer than 31 days per the Endicott court is required).
– You intend to trade as a business, not as a hobby or a passive investment. You have a trading plan, a trading account separate from your (investment) account, and a dedicated workspace or office.
It would be best if you met these criteria consistently throughout the year. You may not qualify for trader tax status if you start or stop trading during the year or have significant gaps in your trading activity. (Part-year TTS qualification is okay.)
What are the benefits of trader tax status?
Trader tax status can provide significant tax savings for active traders. Here are some of the main benefits:
– You can deduct your trading expenses on Schedule C, reducing your adjusted gross income (AGI) and self-employment tax. These expenses include commissions (not brokerage commissions), software, subscriptions, education, interest, margin fees, and home office costs.
– You can elect Section 475 mark-to-market accounting, which allows you to report your trading gains and losses as ordinary income and losses on Form 4797. This way, you can avoid the wash sale rule, which disallows losses on (substantially identical) securities you buy back within 30 days (before or after). You can also fully deduct (within Excess Business Loss EBL and net operating loss NOL limitations) your trading losses against any income without being subject to the $3,000 capital loss limitation or the 3% (2%) AGI threshold for itemized deductions. (The 2017 Tax Cuts and Jobs Act TCJA suspended 2% miscellaneous itemized deductions from 2018 through 2025. TTS business expenses are deductible from gross income.)
– You can qualify for the 20% qualified business income (QBI) deduction if you have Section 475 income and your taxable income is below a certain threshold ($164,900 for single filers and $329,800 for married filing jointly in 2021). The QBI deduction reduces your taxable income by 20%, which lowers your effective tax rate.
– You can form an LLC or a corporation and elect S-corp status, which allows you to pay yourself a reasonable salary and deduct health insurance premiums and retirement plan contributions as employee benefits. These deductions also reduce your AGI and your self-employment tax.
Conclusion
Trader tax status is a valuable tax benefit for active traders who meet specific criteria. It allows you to deduct various business expenses and take advantage of unique tax treatments that lower your taxable income and tax liability. However, qualifying for trader tax status is tricky; you must (be ready to) prove (in an IRS exam) that you trade as a business with sufficient frequency, volume, and consistency. You must also comply with various rules and regulations regarding accounting methods, entity structures, and tax filings. Therefore, it is best to consult a professional trader tax advisor who can help you determine if you are eligible for trader tax status and how to maximize its benefits.
Trader Tax Status:
If you are an active trader who buys and sells securities for a living, you might be interested in trader tax status (TTS). (The intention of making a living is good enough). TTS is a special designation that allows you to deduct your trading expenses as business expenses and enjoy other tax benefits. However, only some people who trade qualify for TTS. You must meet certain criteria and follow specific rules to claim this status.
What are the benefits of trader tax status?
Trader tax status comes with several advantages, such as:
– You can deduct your trading-related expenses, such as margin interest, education, software, data feeds, subscriptions, home office, and more. These expenses are reported on Schedule C or the pass-through entity tax return, reducing your taxable income.
– You can elect Section 475 mark-to-market (MTM) accounting for your trading securities. You can treat your open positions as sold at fair market value on the last day of the year and report the unrealized gains or losses as ordinary income or loss. (Section 475 realized gains and losses are ordinary gains or losses, too.) This way, you can avoid the wash sale rules that defer losses on securities and the $3,000 capital loss limitation. Although this is uncertain, you might also qualify for the 20% qualified business income deduction on your Section 475 income.
– (Using an S-Corp), you can set up a retirement plan for yourself and your spouse (if applicable) and make tax-deductible contributions. A retirement plan can help you save for your future and lower your tax bill.
How do you qualify for trader tax status?
There is no election or application for trader tax status. It is based on your facts and circumstances and how you conduct your trading activity. The IRS needs to define TTS clearly, but it has provided some guidelines and court cases to help you determine eligibility.
According to the IRS, to qualify for trader tax status, you must:
– Trade substantially, regularly, frequently, and continuously. You need to meet no fixed number of trades or hours per day or week, but generally, the more trades and time you devote to trading, the better. A good rule of thumb is to average at least four daily transactions and 15 hours per week. (Green looks for a frequency of nearly four days a week with trade executions.)
– Seek to profit from short-term price swings of securities. It would be best if you did not hold securities for long-term appreciation or income. Your holding period should be less than 31 days on average.
– Have the intention to trade as a business. You should treat your trading activity as a serious and professional endeavor, not a hobby or a personal investment. You should have a separate trading account (or accounts), a dedicated workspace, a written trading plan, and proper records and reports.
How do you claim trader tax status?
If you meet the criteria for trader tax status, you can claim it on your tax return by reporting your trading expenses on Schedule C or the pass-through entity tax return. I would also like to ask you to please attach a statement explaining why you qualify for TTS and how you calculated your costs.
Suppose you want to elect Section 475 MTM accounting for your trading securities. In that case, you must file a timely election statement with the IRS by April 15 of the current year (or March 15 for partnerships and S corporations). You should also attach a copy of the election statement to your tax return. (New entities can elect Section 475 by internal resolution within 75 days of inception.)
If you want to set up a retirement plan for yourself and your spouse (if applicable), you must do so by December 31 of the current year. (A SEP IRA can wait until the tax return due date.) You can choose from various plans, such as a Solo 401(k), a SEP IRA, or a defined benefit plan. You should consult a tax professional to determine which plan is best for you and how much you can contribute.
Conclusion
Trader tax status is a valuable tax benefit for active traders who qualify. It allows you to deduct your trading expenses as business expenses and elect Section 475 MTM accounting for your trading securities. It also enables you to set up a retirement plan for yourself and your spouse (if applicable) and make tax-deductible contributions. (You need a TTS S-Corp to deduct a retirement plan and 2% owner health insurance premiums.)
However, trader tax status is not automatic or easy to obtain. You must meet certain criteria and follow specific rules to claim this status. You must also keep accurate records and reports of your trading activity and expenses. You should seek professional advice from a CPA or a tax attorney specializing in trader taxation before claiming TTS on your tax return.
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