|
PureBytes Links
Trading Reference Links
|
I though this information would benefit some readers, and be of interest
to the rest. I am submitting the text of this article to several publications
in the industry, and since I am a reader of the Omega List, I wanted to share
the information with those who may benefit from it.
Traders who trade their own account, and have losses, are facing an
imminent deadline. Few traders, if any, recognize its significance in terms
of their tax liability. This is especially true if their trading loss
exceeds $3,000.
Trader Status is a hybrid category, falling somewhere between an investor
and a professional market maker. The distinction here is that Traders trade
their own account (rather than handling transactions for outside customers),
but do so at a high enough level of activity that they can be treated as
businesses in the eyes of the IRS. This is important, as it allows many
deductions to be taken that investors lose due to phase outs and limitations.
Furthermore, the deductions are taken as part of the computation of adjusted
gross income, rather than as a subtraction from it, making them worth even
more. Many TradeStation users may qualify for the benefits of Trader Status
because of the nature of their trading.
As of 1997, the distinction of being a Trader has taken on a greater
significance. With more and more people qualifying as "off the floor and at
home" Traders, Congress has given more credibility and benefit to electing
Trader Status. They have expanded Section 475 of the tax code, to allow
Traders to deduct their trading losses in full, rather than being limited to
a net $3,000 loss each year as is the case with investors. Another
advantage for Traders is that, unlike market makers, their trading income
is, in most cases, still not subject to self employment tax.
Unfortunately, even if you qualify, you may be running out of time to
utilize this benefit in both 1998 and 1999. In fact, you may have already
lost the opportunity to do so.
In March, 1999, the IRS issued Rev. Proc. 99-17 which established
deadlines for making a Section 475 election. In 1997 and 1998, a Trader
could wait until the end of the tax year (and indeed determine if there were
losses), prior to deciding whether or not to make the election. Starting in
1999, however, the rule has changed. The IRS now mandates that if you want to
elect Section 475 for 1999, you must have made that election by attaching a
statement to the first extension of your 1998 tax return (ie. by April 15th,
1999).
But there is a significant loophole the IRS has overlooked!
If you still haven't filed your 1998 tax return, and have a valid second
extension, you can still elect Section 475 on your 1998 tax return when you
file the return (up until October 15th). By having elected this on your 1998
tax return, you automatically will qualify to use it on your 1999 tax return!
If you are a Trader with a properly extended 1998 tax return, and have
losses in excess of $3,000, you may want to consider electing Section 475 on
your 1998 tax return. The election surely would be beneficial for you to make
if you had losses in 1998, but may be advantageous to you even if you had
trading profits in 1998 and loses in 1999, solely so you can deduct your
entire 1999 loss in 1999.
As a case in point, I will illustrate two taxpayers with the same exact
income and expense figures, only substantially different tax situations. The
numbers I use here are slightly exaggerated to make the point, but the
difference is significant with any numbers.
"N. Vestor" came to me in early 1998 with a tax return prepared by
another practitioner. This taxpayer had a trading loss of $100,000, rental
income of $200,000, other income of $200,000 and investment expenses of
$200,000. (He must have bought more than a few of those near perfect Trading
Systems!) He had already paid in $100,000 in estimated tax payments for 1998
and was quite upset that he still owed a balance of $7,660. He could not
understand how he could have incurred such high losses and spent so much on
his "investing", but still owe the government a tax balance.
After examination of the facts and circumstances, I discovered that "N.
Vestor" was really "A. Trader" in disguise. In making such a determination, I
was able to take his "investment expenses" in full, as trading expenses, and
further to elect to take his losses as ordinary, via a Section 475 election.
The difference in Federal tax liability was astounding. Instead of owing
$7,660 the government, "A. Trader" was now due a refund of $76,036!
Same figures, different tax classification!
There is no box to check on the tax return for one to elect Section 475;
the way to do so is to file a Form 3115 with your return (and to file another
Form 3115 independently with the IRS). This is a somewhat complicated
form, and not the easiest to fill out properly. And, because there is a
downside to making the election, you do not want to make this election
without at least some professional guidance.
In the case of commodity Traders and Traders of OEX and certain other
types of index options, there is a preferred tax treatment which would be
lost with a 475 election (OEX options are taxed as 60% long term capital
gain). Also, once the election is made it locks you into doing it every
year, unless you request a recission from the IRS. We are not yet sure how
the IRS will respond to such a request.
In the final analysis, the significance of qualifying for Trader Status
is even greater now because there is much more at stake - that is, the
ability to deduct capital losses as ordinary, beyond the $3,000 per year
limitation. The IRS has tried to take back some of what Congress has given
Traders this year, but if you are savvy, you can still take advantage of the
benefits you are entitled to. Be wary, though, of the new deadlines for
making such an election. It can be the difference between whether you owe
money on your tax return, or get a refund!
If any reader wants a free questionnaire to see if they qualify for
Trader Status, or if anyone wants more information on the 475 election, email
me at tbtesser@xxxxxxxx
"Keep the IRS out of your pockets, and away from your trading profits!"
Regards,
Ted Tesser, CPA
|