Profiting from Day Trader Tax Benefits

A six-figure income (or more)… 30-hour workweeks… No boss… There are plenty of reasons why a successful day trader’s lifestyle is attractive. But who’d have thought that tax benefits were one of them?

Truth be told, active market participants can take home more of their trading gains by taking full advantage of their tax situation. And as year-end quickly approaches, now is the ideal time to take full advantage.

Today, we’ll look at how you can use a nuanced portion of the tax code to offset more losses, write-off more trading expenses (including newsletter subscriptions), and even get Uncle Sam to cover a chunk of the bill the next time you go out to a strategy dinner with a fellow trader.

By making the right choices, you may be able to save substantially on your taxes. As a self-employed trader nearly everything you purchase that is directly related to your business of trading can be a deduction and can be deducted from your gross income on your federal income taxes.

The catch to all these great tax benefits is of course that you must qualify as a trader. Electing “trader status” or trading under an entity (like a corporation or an LLC) enables a trader to pay for trading expenses with before-tax money, not after-tax money, a HUGE benefit!

Electing “Trader Status” with the IRS

When it comes to day trader tax deductions, the three most important words are “Ordinary, Necessary and Reasonable.” According to the IRS, to qualify as a trader your must elect trader status before April 15th using IRS form 475(f) and meet the following criteria:

• You must seek to profit from daily market movements in the prices of securities and not from dividends, interest or capital appreciation

• Your activity must be substantial, and

• You must carry on the activity with continuity and regularity

One of the perks of electing the Trader Status with the IRS is the “mark to market rule”: the ordinary investor may only write off $3,000 in stock losses per year, but under trader status there is no limit. Trader status also eliminates the “wash sale rule”, a rule that prohibits an investor from claiming a loss on a stock if they re-buy it within 30-days of the sale

Granted a trader that needs to use this benefit often won’t be in the trading business for long!

The real benefit of Trader Status with the IRS the bevy of deductions that become available to you. As an ordinary investor, many deductions are limited by percentages of your adjusted gross income… but under the right entity, for traders there are no limits to these expenses! Be mindful, however, that electing trader status will increase your risk of audit, as the IRS looks for taxpayers who are incorrectly claiming these deductions.

Trading Under an Entity to Capture Maximum Deductions

Trading under an entity refers to trading under the umbrella of a LLC, S-Corp, or C-Corp – anyone can form one of these entities for as little as $100 by filing the right paperwork with their state. When you trade through an entity, your trading expenses offset your trading profits to determine what you owe Uncle Sam at the end of the year.

So, what kind of expenses can you deduct? As a trader, you can deduct the full cost of education, including seminars, class tuition, books and other expenses, as long as the purpose of the class is to maintain or improve skills related to your trading.

Other trader deductions can include trading books, subscriptions to financial newspapers and magazines, research newsletters, news services, real-time quotes, charting and analysis software packages, and other dues and fees. If it is an expense you incur in your trading business then it is probably a deduction.

If you trade from home then you may be able to claim the home office deduction, which is based on the percentage of your home that you use exclusively for your trading business. (You must have a separate room that is devoted solely to trading; Daytrading on your couch in the living room won’t qualify.)

You also can take IRS tax deductions for most business costs, including a dedicated telephone line, business calls, cell phone, office supplies, business cards and miscellaneous brokerage fees. Don’t forget costs for computers, monitors and any equipment needed in the course of trading. Keep in mind that services and equipment not used exclusively for trading can only be deducted in proportion with its business use – if you use your cell phone for brokerage orders 75% of the time, and personal calls 25% of the time, only the 75% is a qualified expense.

Expenses associated with travel and entertainment are fully deductible: airfare, lodging, rental car, taxis, meals, phone bills and tips. You can also deduct 50% of the cost of a business meal as long as business was discussed before, during or afterward – but make sure you have receipts (a good tip is to write the purpose of the meeting on the back of the receipt for later reference). When it comes to taxes the more documentation you have the better!

Stock trader business deductions are plentiful – as long as you qualify for trader tax status and correctly elect the mark-to-market accounting method.

Happy Trading,
C.J. Thornton
BuySellShort.net
Penny Sleuth

[Editor’s Note: This article is designed to be a guide – we’re not tax advisors. Make sure that you consult your CPA or attorney before making any critical tax decisions. We all know how complex tax law can be; don’t get on the IRS’ bad side just because a certain situation doesn’t apply to you…

To learn more about trading – and to get more details on forming a trading entity – check out C.J.’s website: BuySellShort.net.]

December 9, 2010

Profiting from Day Trader Tax Benefits was originally featured in the Penny Sleuth. Check out Wall Street’s 5 Most Profitable Penny Stock Patterns Report.

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