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At 07:32 AM 3/18/98 -0800, you wrote:
>Hi,
>I took an early out on my job and stuck the pay off in an IRA. I now stare
>at bar charts on my computer all day long. Trading is my only source of
>income.
>I need to get some tax books regarding tax laws for traders. Does anyone
have
>any good book recommendations? My new job status would be reported next year
>for 1998 taxes. What proof does the IRS need to be qualified as a pro trader?
>Thanks!
>Don Becker
>dbecker@xxxxxxxxxxxx
>
By coincidence, a trading buddy of mine sent me this the other day.... it
may point you
in the right direction.
Am posting this to the list at large, since this may be of interest to
everyone.
Dave
TSC Tax Forum: Tax Forum Debuts with Special Feature for Day Traders
By Tracy Byrnes
Staff Reporter
3/14/98 12:15 AM ET
Holy tax questions! The tax forum's email bag is stuffed! Close to half of
all responses we got were questions related to day trading. We're combining
those into one big primer this week. Hopefully, we covered your question in
the process. Gotta do the boilerplate: This is a general primer, we can't
know or anticipate specifics that might apply to you.
We've included a few miscellaneous tax questions this week as well.
Next week we'll conquer the mighty Roth IRA and finish up with your other
questions. By then we'll certainly need more, so send them, along with your
full name, to taxforum@xxxxxxxxxxxxxx
* * * * *
So What Am I?
As far as the IRS is concerned, there's a big difference between a trader,
an investor and a dealer. Although we discussed this in last week's Options
Forum, here's a quick review. A trader looks at the short horizon only. He
wants to make quick profit today and makes a ton of trades trying to
accomplish that.
How many trades? Ken Strauss, vice president of Morris, Brown, Argiz, says
that a good rule of thumb is 200 per year. So if you do spend your day
trading, make around 200 trades per year and have no other full-time job,
you just may qualify.
A dealer "engages in transactions with customers" says Richard Shapiro, an
Ernst & Young securities tax partner, and therefore must be licensed. We
will not be discussing their tax implications.
Everyone else is an investor.
Look, Ma! I'm a Trader!
Bruce Sunderland, Joel Fox and Paul Snyder all asked: What are the benefits
of qualifying for trader status?
Aside from the perk of working in your pajamas all day, this is your
full-time job. It is your business. So you can fill out Schedule C --
Profit or Loss From Business, the way that the person who runs his own
carpet-cleaning business does. Everything from income to expenses goes on
Schedule C. The upshot is there's no limit to the losses you can take.
That's the good part. The bad part is that gains are taxed at your ordinary
tax rate, which could be up to 39.6% on the federal level. It may not be
such a big deal though because most, if not all, of your trades were
probably short term, so you wouldn't get the lower capital gains tax rate
anyway.
As a Trader What Can I Write Off?
Tim Karinen, Kim Hoang, and many others were dying to know.
"Everything that is necessary to help you perform your job," says Strauss.
That includes your computer, furniture, publications, online trading
services, even your TSC subscription if you use it to help you trade
(pardon the plug!).
Section 179 of the IRS Code says that a small business can write off up to
$18,000, so start tallying. This figure will increase to $18,500 for 1998.
Note that if you fill out Schedule C, you qualify for the Keogh plan, which
is the self-employed version of the 401(k). And, in response to Ron Watts'
question, you're definitely free to contribute to an IRA. It's only when
you're already in a company-sponsored pension or 401(k) plan that
limitations may apply.
I'm Just a Plain Vanilla Investor
Now if you're an investor, you have to fill out Schedule D -- Capital Gains
and Losses. Here, your losses are limited to the extent of your gains plus
$3,000 against your ordinary income. Be sure to check the new 1997 rate
schedule as you figure this out.
All related investment expenses (again, that's TSC) will be taken as
deductions on Schedule A -- Itemized Deductions. The bummer is that they
might be limited, depending on your total adjusted gross income. So you may
not get full dollar-for-dollar benefit.
But What About the Schedule D?
If you're an investor who has made tons of trades in 1997, how do you fill
out Schedule D? There's surely not enough room to write every trade you
made on the form.
Strauss says to just attach your brokerage statements to your tax return.
Write "See attached" on lines 1 and 9 of the form. You still must show the
net short-term and net long-term amounts on lines 7 and 16, but you don't
have to rewrite everything, as long as you include the statements.
This Part Is for Both of You!
Now this part applies to both investors and traders. So you decided to sell
the most expensive shares first because you were being cautious of capital
gains. Good move. But how do you prove to the IRS which shares you decided
to sell?
Well, to start, you do not have to identify on your return that you own
more than one lot of specific shares. All you need to show on Schedule D is
the date purchased and the date sold. You can decide what date of shares to
sell. Just make sure you mark in your records that they're gone. You can't
sell them twice!
Dan Thomasson brings up a good point. What about if you're audited by the
IRS? Golden rule of accountants: Keep everything! If you are audited, you
can verify your trades with your brokerage statements. You should also have
the trade slips of the equities you sold. If by chance you do not have
these (shame on you!), call your broker and give him the approximate date
when you bought and sold the security, and he may be able to go back and
find it. But get your records in order now -- just in case Uncle Sam comes
knockin' someday.
By the way, Michael Mathews pointed out that options are not reported on a
1099 form. Why? We're not sure, nor do we want to try to understand the
IRS' thought process. But trust me, they will find you. So make sure you
report options on your tax return. There is definitely a paper trail. If
your broker was ever audited, the government would be able to trace the
sales to you, no problem.
Time for the Wash Sale Rule. Ugh!
In a nutshell: Your gains on trades are always taxed, but you may not
always be allowed to deduct your losses for tax purposes. Nice guy, that
Uncle Sam.
The idea of the wash sale is that the government doesn't want you to keep
same position and still be able to claim a loss. They prohibit the loss
unless it has truly sustained. So if you buy 100 shares then sell the 100
shares at a loss, you can't buy those 100 shares back. If you did, you'd be
in the exact place you started (with 100 shares), but you'd also have a
nice loss to put on your tax return. See?
Here is the official IRS jargon: "The wash sale rule will result in the
disallowance of a loss if substantially identical stock or securities are
acquired (or a contract to acquire is entered into) within 30 days before
or after the sale of the stock or securities at a loss. When the wash sale
is applicable, the loss is disallowed, and the basis of the new property is
deemed to be increased by the disallowed loss."
First, many of you asked for a better definition of a "substantially
Identical" security. Try this:
"Anything that ultimately ends you up in the same place is substantially
identical," says Larry Foster, KPMG partner in the personal financial
planning group. So if you sell common stock of Microsoft, you can't go out
and buy MSFT call the next day, because that will result in common stock
shares.
Same with convertible preferreds in MSFT. That just gives you that right to
the common stock again.
But if you bought a 20-year MSFT bond, that would be okay. The two are not
related. One's equity, one's fixed income.
You can buy within the same industry to hedge yourself. If you sell AOL and
hop into Yahoo! within the 30-day period, that's cool. The wash sale rule
won't apply.
Now let's look at a wash sale loss example. Carl Wyman traded AOL
continually throughout a three-day period. Let's say those days were Jan.
15 to 17, and that he bought and sold 100 shares and ended up with a $300
loss at the end of the three days. If he is completely out of the stock
after the last sale, he can take the loss, no problem. No problem, that is,
if he stays away from AOL for 30 days. If he goes out and buys more shares
of AOL right away, he can no longer deduct the loss.
But does that buy back mean the $300 loss is gone forever? asks Gary
Sewell. Not totally. Carl's new investment will be adjusted for the
previous loss. Watch. For simplicity, say he bought 100 new shares of AOL
at $100 each (don'tcha wish?). That investment, or cost basis, is $10,000.
But the tax laws say he can tack the previous loss of $300 onto his new
basis. So his cost basis on those shares now becomes $10,300. The bean
counters say he got a step-up in basis.
What makes this step-up in basis a good thing? Well, it's good if he turns
around and sells the shares for $110 each. The sale price of $11,000
results in only a $700 gain. Without the $300 jump up in basis, the gain
would have been $1,000. Gotta like a decrease in taxable gain.
Let's look at another example.
Gary buys 100 shares on Sept. 21. On Dec. 21 he buys 50 more. On Dec. 27,
he picks up 25 more. He now has 175 shares. On Jan. 3, he sells 100 shares
at a big loss. To see if the wash sale rule applies, you must count 30 days
forward and back from the time of sale. If we count 30 days back from the
sale on Jan. 3, we find that he purchased 75 shares within the period. So
because of the rule, 75 of the 100 shares sold are a wash. They won't
count. He can't take those 75 shares as a deduction on his tax return. He
can, however, take a loss on the remaining 25 shares, because they were
purchased more than 30 days ago.
If, after 30 days, he decides to buy more of the same shares, he will get a
step-up in basis from the loss on the 75 old shares -- just like Carl did
above.
The are two books that have been recommended by our readers that cover this
stuff. The first is Taxes and Investing: A Guide for the Individual
Investor by Richard Shapiro, Esq., and the second is The Trader's Tax
Survival Guide by Ted Tesser, CPA. Check them out.
That wash sale loss is a doozy. If you wrote in with specific
options-related examples, your questions will be addressed next week by our
resident options guy, Dan Colarusso, in the Options Forum. Be sure to check
it out.
© 1998 TheStreet.com, All Rights Reserved.
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