Handling your day trading taxes can seem like a daunting task but with this guide you’ll be in a much better position to maximize your profits.
Taxes on Day Trading
Anyone preparing for a career as an active trader needs to make sure they understand the different tax laws associated with it and how to best position themselves from overpaying and to make sure you file correctly.
This includes knowing what you can deduct and the best way to report your capital gains and losses. If you’re a full time trader you may be eligible for trader tax status where you will be allowed to report your trades on a Mark-to-Market status.
Lets face it, taxes are complicated and something we don’t like dealing with but if you set yourself up right you could avoid coughing up a lot of your hard earned trading gains to the tax man.
This article focuses on some of the most important aspects for active traders and taxes.
This shouldn’t be viewed as an all inclusive guideline but it will help the new trader gain a deeper understanding into the complicated world of filing taxes as an active trader.
Trader Tax Status, Do You Qualify?
In order to truly qualify for trader tax status, you need to be active, even if not professional yet.
Active means you are trading 500 round turn trades annually, possibly a little more or less. Your intention must be running a home office or business, and probably working your craft at least three-quarters of available days for trading each year.
The equation usually means 3 to 4 days weekly; doing day trades and swing trades, plus having some serious account holdings while equipped with the tools of trading.
Essentially, if you aren’t clocking in visibly to the straight system, then your chances of successful or legal patterns of behavior are slim. The IRS will focus on tracking the 500 round trip looking for data that is concrete enough to prove for taxation.
So if you qualify in the ways just explained, then the IRS will have their eyes on you. But that is a good thing, the more qualified you are as a trader, the more legitimately you qualify for tax breaks, legal loopholes, and it makes doing your taxes all the simpler.
If you think tax trading is really something you are interested in and something you will do actively, then it is suggested that you should apply for trader tax status.
That is why many people have found myself less likely to apply, but often the need would be of benefit to my family, friends, and even strangers.
Find out if you qualify by visiting the IRS trading page here.
Traders benefit from using Mark-to-Market (MTM) accounting methods by being able to treat any stock you hold after the close on December 31 as if you had sold it at the closing price. So if you were down on the stock at the close then you get to report it as a loss without actually selling it, which can be used to reduce your gains and reduce your tax bill.
MTM allows a trade business to change their tax earning status to avoid a $3,000 limitation on capital losses. Mark-to-Market election allows the person to shift their capital gains or losses, to a reporting of everyday incomes and losses.
This isn’t something that you just get for being a trader, but something that you have to specify in your taxes to the IRS before the deadline, which is usually by the due date for normal taxes, April 18. Although this is often best handled by a tax professional, so that a wrong filing the first year doesn’t impact your business practices for any reason.
If you don’t hold any positions overnight then this will not have much of a benefit for you but it is still worth knowing and understanding just in case you do.
Tax Forms for Full Time Traders
Active trading professionals will need to understand the uses of a few tax forms, depending on what kind of business model you have established (i.e.. sole proprietorship, LLC etc.). Along with your personal tax filing, you should file this form for the first year officially trying to avoid necessary taxes.
Standard trade investors who work as sole proprietors and do not use the mark-to-market accounting method will usually file a Schedule C : Profits Or Losses From Business form. Although sometimes this can trigger an audit. So get the help of a tax professional, if necessary.
Anyone trading in major stocks, options and single-stock futures, but also elects not to use the methods like the MTM should file a Schedule D : Capital Gains and Losses. This form allows recording of short and long term losses or gains, but also things like wash sale adjustments.
There are many tax forms, but most professional active traders should keep these four on hand, as they each are necessary and useful. Especially during the first year tax shift to becoming a full time employed trade specialist.
IRS Form 3115 : Application For Change In Accounting Methods
IRS Form 4797 : Sales Of Business Property
IRS Form 6781 : Gains and Losses From Section 1256
IRS Form 4868 : Application For Automatic Time Extension
Don’t assume you can do everything yourself though, it is always smart to get the advisory of a tax expert before filing anything each year. It can save you a world of problems.
Maximizing Business and Home Office Expenses
There are many advantages of a home office and it is the big tax break for the active trader. Think of your home office space in terms of business write offs and home office expenses. Nearly everything important can be accounted for and used towards maximizing your tax returns.
Such things not to forget are your actual trading computer, usage of the internet or streaming cable, news/marketing data feeds, rented spaces, loss deductions, some commissions and ECN fees.
It doesn’t matter if you work from home, but you should try to localize your home office in a separate space from the other parts of your household. This way there are no discrepancies concerning what is your actual work space, this is a most important distinction, especially if an audit is ever triggered.
Maximizing business and home office expenses is a good thing, but also necessary for professional traders and investors.
Deductions and Educational Expenses
An area that many independent business persons neglect to maximize deductions from are their actual training and education about the trades market. Most educational expenses can be recorded as write offs throughout the tax season.
This could include actual college courses, trading courses, books, manuals, in person training seminars, online webinars, personal coaching, mentoring, and meetings in chat rooms. In some cases, even software training programs maybe deductible, so ask a tax specialist if you are not sure
It is necessary to document such expenses as accurately as possible, but very few things related to real study work can be disputed. Don’t be false or lie about it, just claim your educational deductions and sort our the legitimate expenses with the tax organizations. You might be surprised how much can be written off in this area.
Maximizing IRA Contributions and Retirement Investments
For those who are invested in IRAs, do not pull out. It is essentially to keep maximizing the investments. The rules surrounding taxes on IRAs, 401(k)s, and other retirement planning are simple. The breakdown often causes confusion, so read this carefully.
Withdrawal earnings and pre-taxed contribution from IRAs, 401(k)s, or retirement plans are taxable. While withdrawals on post-tax contribution from401(k)s, IRAs or retirement fund are not taxable. In some cases, it makes sense to pay more taxes up front and save yourself higher rates of taxes in the future.
It really depend on your individual situation. If this is the case, it maybe smart to convert your standard IRAs in exchange for Roth IRAs. In general, qualified withdrawals from Roth 401(k)s, Roth IRAs, and Roth 403(b)s are not taxable.
These basics about filing taxes are meant as a guide for the active trader or professional investor. Always consult a tax professional about individual filing needs. Good luck to you and better trading this year.