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FYI Deadline looms for Traders with Losses!



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    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