Professional Trader Status

[UltradoomY]

Hi all,
In addition to being a HODL'er of TSLA - I have been doing a lot of options trading as well and approaching both a significant amount of trades but also plenty of positive cash flow.
One of the things I have looked at is becoming a "professional trader"
This is an IRS designation that takes advantage of the Mark to Market method of accounting.

Some of the basics -
All expenses related to trading are deductible (computer equipment, trading fees, margin interest, subscriptions to forums and market information)
No wash sale rules apply
Taxes must be paid quarterly
Must hold securities for short term durations
Must make substantial trades and derive income from trading.
Doesn't have to be your only income stream

Any thoughts would be appreciated. PM's are welcome if you do not want to answer on here.
Cheers

 

[adiggs]

In your research thus far - is there any indication that trading related expenses aren't tax deductible (US tax laws).

My understanding is that if I spend $1k for a trade tracking program (as 1 notable example) then I'll be able to deduct that $1k against my investment earnings for the year. I probably won't get to deduct it if the trading results are negative for the year, but that isn't an issue.

Similar for other investment related news / education / trade idea subscriptions, back testing software, or any other expenses that are directly tied to the act of trading.


Sigh - found some specific info:

Trader Taxation

Is it wise to trade in one’s own name and claim trader status? When you file a tax return the IRS treats you as an investor by default.

andersonadvisors.com

The article might be older (it mentions something specific to 2010), but it does seem to clear up my own misconception about trading expenses. Those go into the 2% rule and are only deductible to the extend that they exceed 2% and only if one itemizes.

They do mention setting up as a business.


Here is I think the most relevant IRS discussion of the topic:

Topic no. 429, Traders in securities (Information for Form 1040 or 1040-SR filers) | Internal Revenue Service

Topic No. 429, Traders in Securities (Information for Form 1040 Filers)

www.irs.gov

The money idea here is that one can be a trader in some securities and an investor in others.

The special rules for traders don't apply to those 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).

 

[UltradoomY]

Thanks for chiming in - the tax code update that passed recently allows full expensing instead of the 2% rule - there are multiple additional sources to confirm this, I can PM you a couple of examples

 

[adiggs]

I found some additional info via Investopedia:

Benefits for Active Traders Who Incorporate

Trading through a separate business structure allows active traders access to all of the tax mitigation and asset protection strategies available.

www.investopedia.com

The idea here is that there is a good in-between to trading in one's own name, and achieving Trader status with the IRS. Create a business / LLC in which one conducts their trading. Besides deducting all of the trading expenses against the income it looks like there are some benefits that the business can pay for and fully deduct that individuals use post-tax dollars for. Medical expenses figured prominently in the article.


Definitely not-advice. I'm not a financial planner, tax advisor, attorney; nor do I play one on TV or any other part of my life.

I've previously looked into the trading business structure before but never went anywhere with it. It might be time to reevaluate that.

 

[UltradoomY]

This is where I am at -
I have multiple LLC's already set up for various business' I own or am part owner in such as trailer parks, so I am very familiar with setting it up and reporting, etc.

I just need to set up one for Trading super star LLC or something and then fund it with my trading money.
Having trading separate from the HODL side is extremely important it seems so there is no confusion by the IRS.
Everything you spend money on for trading at that point is expenseable (is that a word?) including forums where you get trading info like TMC!

 

[stealthyc]

Being a professional trader doesn't affect taxation of trading income unless you elect mark-to-market. Then you have to be very careful to differentiate your investments vs trades.

One of the difficulties is the time spent. Right now my trading activity and probably income definitely meets the bill, but it is a lot more difficult to convince the IRS if it is only a part time endeavor.

 

[adiggs]

This is where I am at -
I have multiple LLC's already set up for various business' I own or am part owner in such as trailer parks, so I am very familiar with setting it up and reporting, etc.

I just need to set up one for Trading super star LLC or something and then fund it with my trading money.
Having trading separate from the HODL side is extremely important it seems so there is no confusion by the IRS.
Everything you spend money on for trading at that point is expenseable (is that a word?) including forums where you get trading info like TMC!

The LLC thing, even 1 of them, will be new to me.

If you have suggestions for the right sort of professional to help with setting these up, advising on what does and does not work well, stuff like that - I'm interested. I'm sort of thinking that a lawyer that works these sorts of things is a good idea for the setup. And then it sounds to me like a tax accountant for doing the annual taxes is also a good idea (my wife and I do our own taxes, but they've also been pretty simple to date).

 

[adiggs]

https://www.tradersaccounting.com/wp-content/uploads/2018/06/BusinessDecisionGuide.pdf

Upside - seems to be a reasonably thorough compare and contrast among a variety of business formations and from a company that focuses on this business (setting up trading businesses).

Downside - it's also an advertisement for this particular company's services.


I found it useful reading. I have no specific knowledge of this company and their services, or how they compare to other similar companies (presumably they do have competitors) and the services that they offer.

At the very least it seems like they have the right expertise in house to help with the Trader designation.

 

[MikeC]

Sigh - found some specific info:

Trader Taxation

Is it wise to trade in one’s own name and claim trader status? When you file a tax return the IRS treats you as an investor by default.

andersonadvisors.com

From that article, this sounds like a major drawback:

"Mark to market accounting gives you the benefit of avoiding the wash sale rule. The wash sale rule is avoided because mark to market requires you to report gains and losses on all securities held at the end of the year, even if you have not sold them. This is actually a major downfall for this accounting method because you could end up paying excessive taxes before you realize any gains on securities. For example, if a security peaks its price at the end of the year, you will have to pay taxes at that peak as if you have realized a gain even though you have not. When you finally sell such security and the price has fallen off, you essentially have paid a higher tax than you would have had to. Do you remember Qualcomm’s end of year run-ups in the late 90’s and early 2000’s. Can you imagine having to pay 20%+ in gains on stock you never sold that is now worth less than the taxes you owe? Why would you willingly put yourself in that situation?"

 

[adiggs]

From that article, this sounds like a major drawback:

"Mark to market accounting gives you the benefit of avoiding the wash sale rule. The wash sale rule is avoided because mark to market requires you to report gains and losses on all securities held at the end of the year, even if you have not sold them. This is actually a major downfall for this accounting method because you could end up paying excessive taxes before you realize any gains on securities. For example, if a security peaks its price at the end of the year, you will have to pay taxes at that peak as if you have realized a gain even though you have not. When you finally sell such security and the price has fallen off, you essentially have paid a higher tax than you would have had to. Do you remember Qualcomm’s end of year run-ups in the late 90’s and early 2000’s. Can you imagine having to pay 20%+ in gains on stock you never sold that is now worth less than the taxes you owe? Why would you willingly put yourself in that situation?"

The mark to market thing is definitely something to understand. My other reading made that sound like an election rather than a requirement. Then again for day traders it seems like an obviously good choice by avoiding any wash sale problems at end of year, while being a low negative impact due to positions opening and closing fast.

It'd be pretty bad for me with very large unrealized gains in my brokerage account. Marking those to market one year would be .. undesirable.

 

[KTC Lurker]

I've been looking into this for a few months and am actually waiting for a call back from Anderson. My accountant pointed me to them, and I'm certain there are benefits to making some change - the open question is which change is the right one. If any one has success finding a tax lawyer/firm that specializes in this I'd be interested in knowing more detail.

I'll, of course, share anything I learn when I get a call back from Anderson. I'd like to get this figured out before the EOY so I don't pay a needlessly high tax bill.

 

[adiggs]

I've been looking into this for a few months and am actually waiting for a call back from Anderson. My accountant pointed me to them, and I'm certain there are benefits to making some change - the open question is which change is the right one. If any one has success finding a tax lawyer/firm that specializes in this I'd be interested in knowing more detail.

I'll, of course, share anything I learn when I get a call back from Anderson. I'd like to get this figured out before the EOY so I don't pay a needlessly high tax bill.

I appreciate anything you learn and can share. I would also like to find a firm with focus / expertise in this area. And like you I'm facing a high tax bill this year and I'd like to manage that down some if I can.

For those in a high income tax state, an easy tax improvement strategy is to move somewhere with a low income tax rate. Oregon - 9% income tax; Washington - 0% income tax. I need to move to Washington

 

[Discoducky]

I appreciate anything you learn and can share. I would also like to find a firm with focus / expertise in this area. And like you I'm facing a high tax bill this year and I'd like to manage that down some if I can.

For those in a high income tax state, an easy tax improvement strategy is to move somewhere with a low income tax rate. Oregon - 9% income tax; Washington - 0% income tax. I need to move to Washington

I have room on my .

I think this is super helpful: Topic No. 429 Traders in Securities (Information for Form 1040 or 1040-SR Filers) | Internal Revenue Service

Calls out kinda specifics and I feel like I totally qualify, just need to avoid the end of year unrealized gains thing as that would be catastrophic.

I'll need an account that understands this as well as a lawyer most likely but this is super interesting and would allow me to retire from my tech job without issue. Thx @UltradoomY !!!

 

[Chenkers]

I can't comment on the US situation, but here in Australia you are automatically considered a professional trader by our tax office if you do more than a few dozen trades in a year. So I well and truly crossed that threshold long ago. The treatment is similar to the US where I can deduct expenses and losses from regular income and my trading is no longer eligible for CGT discounts. I did get some accounting advice that said I could segment my HODL shares off as investments to still qualify for CGT discount, while the regular options trading is counted as professional trading.

 

[adiggs]

I have room on my .

I think this is super helpful: Topic No. 429 Traders in Securities (Information for Form 1040 or 1040-SR Filers) | Internal Revenue Service

Calls out kinda specifics and I feel like I totally qualify, just need to avoid the end of year unrealized gains thing as that would be catastrophic.

I'll need an account that understands this as well as a lawyer most likely but this is super interesting and would allow me to retire from my tech job without issue. Thx @UltradoomY !!!

The tradersaccounting link above - it looks like that's a company that does these sorts of specifics. Figure out the specific legal entity structure to get the best results, set 'em up, get the bookkeeping setup and even do it for you if desired, and then business and even personal tax returns if desired. All of these services stack up of course, but the overall price looks pretty reasonable.

I have no idea where they fall in the pantheon of such companies - I've never known of this company (or presumably competitors) before today, but the idea of a tax/law firm that specializes in this sure does sound appealing to me.

 

[jeewee3000]

Not knowing anything about US tax laws, I can't add anything of value here...

But just wanted to drop by and wish you good luck, @UltradoomY !

 

[stealthyc]

The mark to market thing is definitely something to understand. My other reading made that sound like an election rather than a requirement. Then again for day traders it seems like an obviously good choice by avoiding any wash sale problems at end of year, while being a low negative impact due to positions opening and closing fast.

It'd be pretty bad for me with very large unrealized gains in my brokerage account. Marking those to market one year would be .. undesirable.

It is an election, but it does not mean automatically that 100% of your holdings become mark-to-market. You can specify particular holdings and new positions as "investments" which will continue to have capital gains rather than mark-to-market tax accounting. As I understand it the typical way is to have them in a separate accounts, though I am certain that is not a requirement, the requirement is just that you clearly document which is which.

 

[UltradoomY]

So of course - not a lawyer, not advice -
What I have learned from my accountant and lawyer is that I will need to create an LLC (doesn't have to be done this way, you can just be you and qualify but it makes it "murky" for the IRS)
Then send my trading money over to fund the business - my HODL investments will have to stay in my personal brokerage account and create a new account for the business where I will be trading.
This is sort of problematic as my core holdings form the basis for my account "margin" when I am selling spreads.
So will need to do some more building of the cash balance or cash out some long term shares and send them to the business.
You can technically have everything in one account but I have been advised against this and would throw up some huge red flags from the IRS and have the audit man or woman come knocking.

One the business is set, funded and trading - the mark to market accounting is easier to deal with since everything should be short term. Meaning you cash everything out before the 31st of December and rebuy in January - so not worries about a dip.
Short term thinking in this account, but you can absolutely pay yourself and fund a SEPP or 401L, Roth or just put it into you bank account and buy more long term holdings in your main account.

Be careful to make sure all purchases and expenses are done after your business is created and funded.
Makes life easier on the taxes.

 

[stealthyc]

So of course - not a lawyer, not advice -
What I have learned from my accountant and lawyer is that I will need to create an LLC (doesn't have to be done this way, you can just be you and qualify but it makes it "murky" for the IRS)
Then send my trading money over to fund the business - my HODL investments will have to stay in my personal brokerage account and create a new account for the business where I will be trading.
This is sort of problematic as my core holdings form the basis for my account "margin" when I am selling spreads.
So will need to do some more building of the cash balance or cash out some long term shares and send them to the business.
You can technically have everything in one account but I have been advised against this and would throw up some huge red flags from the IRS and have the audit man or woman come knocking.

One the business is set, funded and trading - the mark to market accounting is easier to deal with since everything should be short term. Meaning you cash everything out before the 31st of December and rebuy in January - so not worries about a dip.
Short term thinking in this account, but you can absolutely pay yourself and fund a SEPP or 401L, Roth or just put it into you bank account and buy more long term holdings in your main account.

Be careful to make sure all purchases and expenses are done after your business is created and funded.
Makes life easier on the taxes.

The stumbling block for me is indeed the fact that I use my margin exclusively for short term trading, and as such need large holdings in the same account. I am very unsure that cashing out holdings to fund a trading business would be a wise financial move long-term. On the other hand, audits are not the end of the world, if you really document things well it is just an irritation.

 

[bballshinobi]

My accountant advised me to set up a C Corp so my short term gains aren't taxed at 24%+ but at the 21% corp rate. Expenses are also easier to deduct. The downside is the inconvenience when you want to take money out from the corporation.