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Realtraders,
Below is an article which I copied from TheStreet.com regarding trading
and taxes. I thought I would post it because every year at this time this
topic becomes prominent on the Forum.
Hope this helps,
John Boggio
Can Traders Use TaxCut and TurboTax?
<Picture>By Tracy Byrnes
Staff Reporter
1/23/99 12:19 AM ET
http://www.thestreet.com/funds/taxes/681575.html
<Picture>Editor's note: Day traders have some unique needs when tax time
rolls around. In this series of stories, which runs through Monday, TSC tax
reporter Tracy Byrnes, with some help from TSC contributing editor Gary B.
Smith, guides traders through the maze. Be sure to read the introduction to
the series, and join Byrnes and trader tax expert Ted Tesser for a Yahoo!
chat Tuesday at 5 p.m. EST.
Welcome to a special edition of Tax Forum dedicated to day traders'
questions. Among the questions we'll tackle today: How do I handle margin
interest? What about retirement options? And what if my spouse has a real
job?
Before we get to your questions, we'll examine the two most popular
tax-filing packages to see whether they're suitable for traders.
Next week, we'll return to our regular format, so please keep sending any
tax questions -- trader-related or not -- to taxforum@xxxxxxxxxxxxx, and
please include your full name.
Can Traders Use TaxCut and TurboTax?
Neither of the two best-selling do-it-yourself tax packages -- Intuit's
(INTU:Nasdaq) TurboTax and Kiplinger's TaxCut -- are configured to handle
the reporting needs of traders who elect to mark to market their trades.
That means you can forget about filing electronically. I'll tell you why in
a moment.
The programs will work just fine if you elect trader status and do not mark
to market your trades. (Check out part two of our Taxes for Traders series
for the details on the mark-to-market election.)
But if you are electing to mark to market your trades and still want to use
one of these programs, you should be aware of a key reporting issue: The
programs cannot automatically handle the transfer of your capital gains or
losses from Schedule D -- Capital Gains and Losses to Schedule C -- Profit
or Loss from Business. You'll have to take some extra steps. Here's how it
works.
As a trader, you will file Schedule D to account for what is reported on
Form 1099s from your broker. As we detailed in part two of the series, you
must then write in a sum that will zero out your Schedule D balance so you
can enter those gains or losses on line 1 of Schedule C.
Sounds fine, right? Well, here's the first problem: Under normal
circumstances, the total tax on your return is the smaller of your
capital-gains tax or your regular tax. If your capital-gains tax is
smaller, that's what the software will tell you to pay. But as a trader who
elects mark to market, you should not be paying any capital-gains tax,
regardless of the amount.
You manually zeroed out Schedule D, but the tax program doesn't know it, so
the capital-gains number still will be carried forward to Form 1040 to help
determine your overall tax.
Here's the second problem: If you elect to mark to market, you report all
your gains on Schedule C. As a trader, you are not subject to
self-employment tax. But these programs will automatically calculate
self-employment tax on Schedule C income, says Brenda Hochberg, director of
federal tax software development at Kiplinger's TaxCut.
What should you do? Here's an option.
You can create two federal tax returns in these programs -- one for the
Internal Revenue Service and one for worksheet purposes.
In the worksheet file, download all your trades onto Schedule D so that
your gain or loss is calculated.
Now input your gain or loss on line 1 of Schedule C in the worksheet file.
Enter everything, including all your expenses, in that "fake" form. The
software will calculate your net profit or loss.
Now print out both of those worksheets and include them with your real tax
return. Just be sure to write "WORKSHEET" across the top to alert the IRS.
>From here, manually enter your total gain or loss from line 32 of the
worksheet Schedule C onto line 21 (other income) of your real Form 1040,
says Hochberg. This will then subject your income to the ordinary tax rates.
This option makes sense, says Keith Washington, group product manager at
TurboTax. But don't even think about filing this mess electronically. It'll
never go through to the IRS correctly. Perhaps that will wake the IRS up to
the fact that the tax forms really need to be adjusted for those
mark-to-market traders out there, says Washington.
What If My Spouse Has a 'Real' Job?
If your spouse works in a regular job, can you still qualify as a trader?
-- Adrian Byram
Adrian,
In part one of the Taxes for Traders series, I said you're not a trader
unless your family's next meal depends on your success. That threw some of
you off. What if you are a breadwinner, but not the only one in the
household?
The thing to keep in mind is that trading must be your primary business,
not a sideline or a hobby. As long as you meet all the requirements
described in part one of the series, you can file as a trader, regardless
of how much money your spouse makes or what he or she does for a living,
says Gail Winawer, tax securities partner at American Express Tax &
Business Services in New York.
What About Retirement?
What retirement options do traders have? I have an IRA, but would like to
expand my retirement account exposure. I understand I need to actually pay
myself a salary (and double tax myself) to qualify for a SEP-IRA.
-- Dave Clemens
Dave,
You need earned income to contribute to an IRA. But in most circumstances,
a trader generally doesn't have earned income. In addition, a trader who
elects to mark to market does not pay self-employment tax. So a trader
generally cannot contribute to a retirement plan.
The only way you could contribute is if your spouse had earned income or if
you were receiving alimony. Because you already have an IRA, I am assuming
one of these situations applies to you.
But you have to set up your trading business as a limited liability company
(LLC) or an S-corporation if you want to pay yourself a salary, says Ted
Tesser, CPA and trader tax specialist in Boca Raton, Fla. That will give
you the earned income you need to contribute to a retirement plan. Then
your new business can set up a SEP-IRA, Keogh or other retirement plan. And
you could set up a personal IRA.
You will now owe Social Security and Medicare taxes on your salary, but it
may be worth it to fund your retirement.
What Do I Do with Margin Interest?
Could you please clarify the deductibility of interest paid on margin
borrowings through your broker account? When is the interest expense
deductible? Do you need to itemize deductions to take advantage of it? Does
it offset other income or can it be used to increase the cost basis of the
stock purchased?
--Mike Yacyk
Mike,
To start, you can't add margin interest to the cost basis, says Tesser.
Section 163 of the tax law says margin interest is treated as an investment
expense. So if you qualify as a trader, you can report the margin interest
as an investment expense on Schedule C.
For an investor though, margin interest is an itemized deduction and
generally is limited to the amount of investment income you have. Form 4952
-- Investment Interest Expense Deduction will help you determine just how
much of that interest will qualify as a deduction in the current year. Any
unused interest can be carried forward to later years. (See Section
163(d)(2) of the tax code for more on that.)
If, as an investor, you decide to take the standard deduction in 1998, you
cannot take a deduction for that margin interest this year. But a portion
of that interest may be carried forward to future years.
What About Guys Like Cramer?
What about a guy like Cramer who manages a hedge fund and trades for his
own account on a short-term basis? Can he file a return as a trader?
-- Tim Truebenbach
Tim,
First, let me say that I don't know anything about Cramer's financial
situation, so I will speak in general terms.
If you run a hedge fund, it's the fund that can elect trader status for tax
purposes -- not the partners who run the fund, says Winawer. If the
partners day trade in the hedge fund, they may very well make this
election. But this will be reported on the partnership's return.
If one of the partners has his own trading account and can prove that he
trades on a "frequent, regular and continuous basis," he can personally
elect trader status.
Can You Attach Brokerage Statements
Back in April, one of your articles indicated that a trader with a high
volume of trades could attach broker statements to Schedule D instead of
manually entering each transaction. What is the current opinion on this?
-- Mike Kohl
Mike,
Anything that will help make things clearer for the IRS should be included
with your tax return. You're not obligated to use Schedule D's additional
form, Schedule D-1 -- Continuation Sheet for Schedule D if you believe you
can offer the IRS something better.
Assuming your brokerage statements are clear and concise and will help the
IRS determine how you calculated your capital gain or loss number, then
sure, include them. If you have a hard time figuring out your brokerage
statements, then forget it.
Nowadays many brokers are providing an additional statement specifically
for the IRS, says Winawer. Translation: They are aware that their
statements are confusing.
And if you believe that you've kept better records than everyone else, then
attach your own schedules. Just be sure to include all pertinent
information for each security, date purchased, date sold, proceeds, cost,
etc.
I Switched Midyear
If someone left a normal salaried job in midyear and started day trading
for his own account, can he file as a trader? Or, in other words, is there
a period of time in the tax year that one must exist as a day trader to
file as one?
-- Deron Goodwin
Deron,
There is no initiation period you must survive to be considered a trader.
You can start whenever you finally get up the nerve to quit your desk job
and trade full time. Remember, the burden of proof is always on the
taxpayer, says Alan Salomon, a CPA in Birmingham, Mich. So your
documentation is key.
Let's say you decide to embark on a full-time trading career Nov. 1. Make
sure you open a separate bank account and trading account on or around that
day, says Salomon. That'll help verify that the last two months of the year
were spent trading.
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TSC Tax Forum aims to provide general tax information. It cannot and does
not attempt to provide individual tax advice. All are urged to consult with
an accountant as needed about their individual circumstances.
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