Let’s talk about trading and taxes.
This is the second installment in our series, “Trading As A Business.”
In the first installment, we talked about the seven things that you need to start trading as a business.
In part two, we’re going to cover how you can set yourself up to have your taxes work in your favor.
So take a deep breath and I promise by the end you’ll feel much better about everyone’s least favorite “t” word.
It’s actually more fun than it sounds. There are some really cool advantages when the IRS recognizes you’re trading as a business.
So before we get started, full disclosure, I am not an accountant and I’m in no way qualified to give you any legal advice or money-saving advice.
This is my opinion and what I have personally experienced.
I’ll give you some resources where you can talk to professionals who know what they’re doing.
When your trading is recognized as a business, you can deduct expenses (like said professionals) from your trading income.
What are the expenses you can deduct for trading taxes?
First, most traders aren’t working out of an office they’re renting somewhere. The vast majority of traders out there (like me) are trading right from the comfort of their homes.
And YES, this is something that you can deduct from your trading business. Because you’re dedicating space from your home for your trading office, this is a legitimate expense you can deduct.
Another very common deduction that likely could apply to you is your education. Yes, just like in school, your trading education is actually tax-deductible. So if you’ve spent any money on courses or seminars you can deduct these for your business.
As we discussed in part one of this series, there are going to be some start-up costs for your new trading business.
In addition, if you had to hire a lawyer or a CPA to form your trading business (possibly like an LLC) this too can be deducted.
We’ll talk more about if forming an LLC for your trading business is right for you.
So then you have so-called ‘tangible property expenses’. What the heck does this mean?
This means things like your computer, which could be a laptop, your monitor, and anything else you need for your trading office. Yes, this could include a desk, mouse, chair, etc.
Now, here’s the other cool thing.
If you’re having to travel for a seminar or some sort of training, you can also deduct your travel expenses as well…pretty cool, huh?
Again, there’s rules and regulations that are applying, I am not a CPA, so please talk to your CPA or a licensed professional, like the one I’ll provide shortly.
So what are some other things you can deduct?
Data. Specifically, market data
As I discussed in part one, you’ll need charting software to help you find your trade setups, and what connects to charts? Market data!
On TradingView (which I use and recommend), it’s really not that expensive, but if you’re paying $10-$60 a month, depending on what market data you’re subscribing to, this is definitely something you can deduct.
What else? Stock borrowing fees. So when you’re shorting a stock, you’re borrowing a stock, and your broker charges you a fee for doing so.
Now, it’s not a whole lot of money with interest rates so low. But none the less, every little bit counts so it’s worth looking into and deducting if applicable.
Are you trading on margin? If so, it too is something you can deduct.
If you trade on margin account (like I like to) and you pay interest on this, again, it’s not a whole lot, it’s probably just a few dollars but you can deduct it.
So as you can see, there’s more than meets the eye with what can (and probably should) be deducted when running a structured trading business.
So the key question here right now is…
What qualifies for a trading business?
Think about it this way.
Let’s say that you’re starting trading and you are not yet as profitable as you want to be.
Or you start drawing a small account and you’re making maybe $10,000-$20,000 a year.
And let’s say that your expenses are higher than your income. Then you have a loss in this trading entity.
When you have an entity, it is on a schedule K (I believe) and you can actually offset this with your regular income.
This is why I say trading and taxes can be fun and interesting if you know what you’re doing and are eligible to be recognized as a trader by the IRS.
Trader Tax Status
Let’s talk about this. What is needed so that the IRS recognizes you as a trader?
So there is actually a statement from the IRS that you can find online.
I’ll highlight a few of the key things that I think are really, really important to understand.
Under traders, special rules apply if you’re trading securities, which means that you’re in the business of buying and selling stocks, or options for your own account.
The IRS, considers this to be a business, even though a trader doesn’t maintain an inventory and doesn’t have customers.
Trader Tax Status Rules
To be engaged in the business as a trader of securities you must meet all of the following conditions:
Number one, you must seek to profit from daily market movements in the price of securities and not from dividends.
You have to been actively trading stocks and options, not just buying and holding, getting paid off dividends.
Your activity must be substantial and you must carry on the activity with continuity and regularity.
Now, as you can see, this is as vague as it possibly gets, right? As a lot of IRS code goes, it’s left pretty vague and up for interpretation.
There isn’t a set amount of time you can hold a security where it does or does not disqualify you as a trader, but just as a rule of thumb, the shorter the better.
For me personally, I typically hold a stock or an option between 5 and 25 days, and there are even times when I’m holding it less than a week. So that definitely qualifies as a trader.
The frequency or dollar amount of your trades throughout the year, the extent to which you pursue the activity to produce an income or a livelihood, and the amount of time you devote to the activity all play a role in your eligibility and status as a trader.
So as you can see, there are a few things that are being considered when determining if you meet trader tax status.
I did some research on the website and I came across Green Trader Tax. It’s a website maintained by Robert Green and he’s got some different info on his site about how to qualify and the services they offer.
Trading Tax Guidelines
There was a court case in 2015 and this court case is being cited by many CPAs to determine whether you, in the eyes of the IRS, should qualify as a trading business.
So let’s talk about all of the different components.
And again, I’ll give you a resource where you can talk to a professional.
As I’ve noted, I don’t do taxes for a living I’m just sharing my knowledge and experiences to this point.
With that said, please seek advice from a professional.
The amount your trading seems to play a significant role to qualify for trader status.
From what I’ve seen, they’re looking for at least 720 trader per year. For whatever reason, this seems like the ‘golden’ number of trades.
In order to qualify for trader tax status, the IRS says you must see that you’re trading consistently, month-over-month.
So this means 720 total trades per year or 60 per month.
And you might say, “Oh my gosh, I can’t have 60 trades per month. That is a whole lot!” Well, hold on. Not so fast.
First of all, here is how a trade is defined:
A trade, in the eyes of the IRS, is counted both on the entry of the trade and exit. So if you were to buy one TSLA option, then a day later close it, this would count as two trades total.
So basically, you know that every transaction consists of a buy and a sell, right? Or the other way around.
So as soon as you trade, it’s already two trades in the eyes of the IRS. This means if you’re doing 60 per month, it actually means that you’re having only 30 round turns.
Now, here’s the other cool thing. So for the IRS in this case, it was determined that scaling in and out does count.
Again, this is the research that I have done, but please take the time to do your own as well.
This means, as an example, if you buy 100 shares, and then you sell later on 50 shares at a certain price, and then you sell another 50 shares.
So this is how you’re closing your position, this counts as three trades. As you can see, it is not that difficult to get 60 trades per month.
Please keep in mind these are not rules, the IRS will take a look at you.
But since there was a court case, this is based on the court case that happened in 2015. I do believe that these guidelines are pretty good.
On average, you’ll want to be active four days per week.
Now again, not saying that it is super easy to obtain trader tax status, but when you do, you have lots of advantages, so it does make sense.
Let’s see, what other guidelines do we have here.
In the court case, the IRS said the average holding period must be 31 days or less.
OK, good. So we already know this, holding period 31 days or less.
No problem for me at all because this is where I personally hold most stocks and options between 5 and 25 days.
Trades Full Time or Part-Time
This is something which I think is a little bit of a gray area. But we should definitely consider it that you are at least considered a part-time trader.
Now here is an important thing.
Part-time and money-losing traders face more IRS scrutiny, and individuals face more scrutiny than entity traders.
So what does this mean?
It means that you should be profitable and it seems that having an entity, and an entity means an LLC, seems to be beneficial.
Spends more than four hours a day, almost every market day on this.
Okay, well, for me, that’s not a problem as I do spend a lot of time talking about, watching, and covering the markets each week both personally, with my mastermind group and of course during my weekly live show on YouTube.
If you’re a market geek like me, then this may not be a problem at all for you.
Again, these are guidelines to keep in mind.
I will give you a resource here to a professional who can help you and see what is happening in your situation.
Has intention to be a full-time trader.
So that’s the idea, I mean, don’t treat this as a hobby, because if you treat it as a hobby, then the IRS probably says, “Well, this is more or less a hobby here.”
So that’s very important.
Has significant business equipment, education, business service, and a home office.
What does it mean?
Well, in the first article we talked about the different things that you need.
Yes, you should have professional software, professional charting software, and you should have trading education.
If you’re jumping into the markets without any education, without having any investment, any significant investment done in the business, the IRS says, “Well, you’re probably just a hobby trader.”
So it does make sense to invest money into your business.
Now here’s the last thing regarding account size.
It says has a material account size. Here the recommendation is that you have at least a $15,000 account.
Now, what does it mean?
Does it mean that you should not trade if you have less?
No, it simply means that if you have less than $15,000 you probably do not qualify just yet for what they call the trader tax status.
Trading Taxes Resources
I want to give you a resource where you get more information.
As you have just seen, I get a lot of information from this website which is called Green Trader Tax, they’re a great company and offer consultations.
Something to be aware of, I believe it’s $270 when you book a consultation with Robert Green or one of his associates.
This is where you can see do you qualify for trader tax status, should you elect MTM accounting, can you benefit from an entity, whatever it is.
There is also another company called Traders Accounting, where you can schedule a free consultation. This can be done through the Rockwell Trading website.
Schedule A Consultation
When you visit the page through the Rockwell Trading website, it brings you to a website where you can have a free half-hour consultation.
During the consultation, you will discover how an entity can save you thousands, what are possible deductions, trader tax status versus investor status, and so on.
Now, it is very, very important, you first meet the few qualifications you need in order to sign up for a consult.
You must be ready to trade as a business in the next two to four weeks.
If you haven’t even started trading yet, don’t book a consultation. It doesn’t benefit you at all right now.
If you’re already trading and making money, have an account that is at least $15,000 or more, have spent significant amounts of money on education, business services, a home office, software, computer, and so on, then YES it does make sense to schedule a consultation.
So again, do not apply for this free consultation if you’re not ready and if you don’t meet the basic criteria.
Also, if you already have a business, don’t ask them for a consultation to help you to get set up. If you have a business, your existing CPA can help you with this.
And right now you must have either U.S. citizenship and/or U.S. residency, because these guys, they know their stuff here in the United States.
If you are in the US this is for you
Long story short, trading and taxes can be fun if you qualify as a trader.
If your trading qualifies as a business, then you can deduct a lot of expenses which is really cool.
Trading Futures, options on futures and retail off-exchange foreign currency transactions involves substantial risk of loss and is not suitable for all investors. You should carefully consider whether trading is suitable for you in light of your circumstances, knowledge, and financial resources. You may lose all or more of your initial investment. The lower the day trade margin, the higher the leverage and riskier the trade. Leverage can work for you as well as against you; it magnifies gains as well as losses. Past performance is not necessarily indicative of future results.