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As usually happens around this time of year, I am starting to see a
preponderance of misinformation about what Traders can and can not do on their
tax return. I don't claim to be the ultimate authority on this stuff, just a
CPA with about 20 years of experience in doing tax returns for Traders.
Therefore, I can tell you what I have been doing for most of those years (and
yes, Robyn, I do sign the returns as well).
I am considered to be an experienced tax practitioner, as well as a Trader
who has made my living doing both for the past twenty or so years (and yes
Mr. Abraham I still do actively trade. Was it the time you stayed late for a
free consultation after one of my seminars that you determined I "no longer
traded", or have you started getting copies of my trade confirms?)
In any event, as a tax professional, I have written several books discussing
"Trader Status," (The Trader's Tax Survival Guide, as was mentioned several
times recently on the Omega List, and it's follow-up The Trader's Tax
Solution, which will be out shortly). My firm also handles the filing of
several hundred individual and corporate tax returns, each year, many of whom
are Traders. If the situation merits, we file the entities as they are
entitled to be filed — under the distinction of "Trader Status."
"Trader Status" is a subjective designation which is not clearly defined in
the Tax Code. It is the Supreme Court and the various District Tax Courts
which have defined "Trader Status" and have given the right to the investor to
claim it under certain circumstances. There have been hundreds of such court
cases since the 1930's starting with Snyder vs. The Commissioner, 1935, in
which the Supreme Court stated that a taxpayer "can be involved in the
business of trading securities".
The problem with interpreting these court cases is that the courts have
reserved the right to make a final determination whether someone is or is not
qualified to claim "Trader Status." Also the rulings have been contradictory,
and in fact may be somewhat outdated now due to changes in the tax law, and
the changes in technology that have transpired over the past few years.
Nonetheless each Trader is evaluated on a case-by-case basis and the Court
takes into consideration factors such as:
1. Frequency of trades
2. Duration of trades (long or short term)
3. Quantity of trades, and several other equally important factors.
The courts have basically stated that a Trader is "one who trades his own
account on a frequent, regular and continuous basis, with a substantial number
of short-term trades." Unfortunately, they never quantify the amount they
consider substantial, nor do they tell us what will qualify as being frequent,
regular and continuous. They also never elaborate on the time period that is
considered short term (be it a day, a week, a month or a year), although for
tax treatment it is a year or less.
Oftentimes the front line IRS tax examiner is not familiar with any of these
cases, nor with the investor's right to claim he is trading as a business.
Most of the time the auditor confuses "Trader Status" with a professional
floor trader.
It was just in The 1997 Tax Act that the Internal Revenue Code specifically
mentioned the Trader. It was under Code Section 475(f) where Congress granted
Traders the right to mark to market their stock positions in the same manner a
floor trader. They also stated,
"Traders in securities (used generically to cover options, futures, options
on futures, and the like) generally are taxpayers who engage in a trade or
business involving active sales or exchanges of securities.... rather than to
customers."
Furthermore, on December 17, 1997 the Joint Committee on Taxation issued its
report (aka the Blue Book). This publication is 549 pages long and explains
the new tax law. Once again they reiterated that Traders are entitled to
certain benefits under the new law.
They also put to rest the issue of paying social security tax on trading
profits once and for all, when on page 181 (Paragraph 1) they stated that it
was "not their intent" to have off -the- floor Traders pay this tax, even
though they would be considered as businesses. They stated that trading gains
would not be considered in determining an individual's "net earnings from
self employment".
Do not take my word for it, look it up in the Tax Code. If anyone has an
issue with whether or not a Trader "trading his own account" is to be
considered a business, or feels it necessary to pay Self Employment Tax on
their profits, perhaps they should have a word with Congressmen Bill Archer of
Texas or William Roth of Delaware who wrote the Blue Book Report. In it both
these Congressmen, as well as the other eight on the committee, interpreted
the law similar to how we do.
We have filed thousands of tax returns under the distinction of "Trader
Status" over the past ten years that I have run my own CPA firm. We have also
turned down thousands of potential "Trader Status" tax returns because they do
not meet the criteria for claiming this designation. We use our own
proprietary Trader Evaluation Questionnaire to gather information necessary
arrive at this subjective determination. And it is only after years of
experience in the field and in the audit arena that I feel qualified to do so.
I must tell you that if I decide someone qualifies as a Trader, I am 99%
confident that I can defend that determination in an audit or an appeals
hearing. Over the years we have only had a handful of audits that have been
disallowed, and the only reason we have not been successful in defending them
is that the cost of doing so would have outweighed the benefits in terms of
billable hours. I must also say that the audit rate involved in filing as a
Trader is no more so than the rate of audit we have with our ordinary tax
clients.
With regard to the issue of an LLC, or whether or not to incorporate, that is
a topic that is beyond the scope of this forum to discuss. Each person's
circumstance will have to determine whether or not an entity other than as
sole proprietor is appropriate for them. I do have a great deal of experience
with this topic, and have recently favored using the Family Limited
Partnership with an LLC as General Partner for trading vehicles in many cases.
When used in conjunction with a separate Nevada entity this combination
oftentimes affords the Trader a unique combination of tax relief, asset
protection, privacy, and flexibility.
And finally, as for "Dr.OEX" who "works for the CBOE and does lots of public
seminars", I find it unfortunate that misinformation is being disseminated by
someone who might be viewed as an authority. This is not uncommon, though;
the issue of Trader Status is one of the least understood areas of the Tax
Code.
As far as my book "being a farce in the investment community", the only real
farce in the investment community is that some people would spend all their
time trying to squeeze the last dollar out of a trade, and then not pay enough
attention to the details of the tax law to know how much of that profit they
could keep.
The benefits of filing as a Trader far and above outweigh the downside risk
if the taxpayer qualifies. It often saves thousands of dollars, and it is one
of the last remaining tax breaks available for Traders. I have had cases
where the difference between filing as a Trader and as an investor has been
worth hundreds of thousands of dollars per tax return.
As far as the "Doctor's"statement that he has "never met anyone who has
successfully survived an audit", perhaps all the people he knows are going to
him for tax advice. I have won the Trader Status issue for many clients on
all levels with the IRS. In fact, I just came out of appeals on a case which
won the taxpayer over a hundred thousand dollars in past due refunds.
I certainly would agree with the "Doctor's" advice given in the last sentence
of his letter which is to "Be very careful ..."
Trader Status is nothing you want to fool around with yourself. I might also
add that defending oneself in an audit with the IRS is also probably not a
good idea — especially if there is any kind of substantial money at stake.
In my opinion, that advice is akin to warning somebody who has a heart
condition not to perform open heart surgery on himself, but rather to seek the
assistance of an experienced cardiologist. Don't you agree Doctor?
Ted Tesser, CPA
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