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Dear Mr. Tesser,
I cannot begin to tell you how much I appreciate your taking the time
to give such a detailed reply to my query about my claim of "Trader Status"
which is now being challenged by the IRS. I will tell you that my basis for
filing in this manner as well as my determination to vigorously contest the
IRS disallowance of this claim is based primarily on what I have learned
from your excellent book. Your detailed reply at this time is really like
added "frosting on the cake". I am pleased to see that you have posted this
to the list as I am sure that there are many others that will benefit from
the clarity and detail of your reply.
Best regards,
Karl
-----Original Message-----
From: TBTesser@xxxxxxx <TBTesser@xxxxxxx>
To: omega-list@xxxxxxxxxx <omega-list@xxxxxxxxxx>
Cc: realtraders@xxxxxxxxxxxx <realtraders@xxxxxxxxxxxx>
Date: Thursday, September 16, 1999 12:43 AM
Subject: Re: The "Trader Status" audit
> Karl, it is still an unfortunate fact of life that many front line IRS
>auditors who get to handle tax examinations probably have had as much
>experience with Trader Status as the person who serves you up a "Whopper",
>Coke and fries at the Burger King. As a CPA, and professional tax
>practitioner, as well as a Trader who has made my living doing both for the
>past twenty years, I have had the unpleasant experience of dealing with
this
>ignorance more than a few times in my career.
>
> Not knowing your situation, I can't comment on whether or not I think
you
>do or do not qualify to file as a Trader, but I will tell you that someone
>with 500 trades should be in a pretty good position. If you want, I will
>discuss it with you further, as I am profoundly offended by the position
>taken by some IRS auditors.
>
> The Internal Revenue Code clearly defines an investor, as well as a
>professional broker/dealer. It also defines what a business is, and allows
>for the deduction of ordinary business expense under Code Section 162.
>
> 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
>IRS should handle it this way, as the Courts have mandated. They take 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 investors' right to claim he is trading as a
>business. Most of the time the auditor confuses "Trader Status" with a
>professional floor trader (having customers).
>
> It was just in The 1997 Tax Act that the Internal Revenue Code
>specifically mentioned the Trader. It was under Code Sections 475 E and
F(1)
>and (2) where Congress granted Traders the right to mark to market their
>positions in the same manner a floor trader.
>
> Code Section 475 used to just apply to floor traders, as the definition
>of a Market Maker and Broker Dealer states which was posted to this list by
>"tagteam@xxxxxxxxxxxxxx This came from the part of Section 475 A and B,
>which was introduced into the law in the Revenue Reconciliation Act of
1993.
>It mandated then that "Market Makers or Dealers in Securities" use this
mark
>to market accounting method for valuing their positions at year end - to
>prevent them from carrying unrealized gains into the new year. Congress
>expanded this section in 1997 and included Traders of their own accounts,
who
>do not have outside customers with subsections E and F(1) and (2). But
>Traders are not required to do so, they have the right to elect to do so.
>
> 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. Although they did not tell us what specifics a Trader must meet
to
>qualify as a business, they did define what a Trader does.
>
> On page 180 of this report, Title X, Section A (Financial Products),
>Subsection 1001(b), they stated:
>
> "Traders in securities generally are taxpayers who engage in a trade or
>business involving active sales or exchanges of securities on the market,
>rather than to customers. Under prior law, the mark-to-market treatment
>applicable to securities dealers did not apply to traders . . ."
(Securities
>is a generic term which applies equally to commodities, futures contracts,
>options, etc.)
>
> If the IRS auditor in question has an issue with whether or not a
Trader
>"trading his own account" is to be considered a business, perhaps he should
>have a word with Congressmen Bill Archer of Texas or William Roth of
Delaware
>who wrote the report. In it, both these Congressmen, as well as the other
>eight on the committee, interpreted the law similar to how you did.
>
> Usually referencing the auditor to the court cases will be enough to
>convince them, and I have listed a few of my favorites at the end of this
>post. However, sometimes the issue must be taken above the head of the
>front-line auditor to his or her supervisor or even to Appeals, in order to
>find someone familiar with this aspect of the law.
>
> My firm has filed thousands of tax returns under the distinction of
>"Trader Status" over the past ten years. We have also turned down
thousands
>of potential "Trader Status" tax returns because we felt that they did not
>meet the criteria for claiming this designation.
>
> I must tell you that if I evaluate someone 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.
>
> The benefits of filing as a Trader far and above outweigh the downside
>risk if the taxpayer qualifies. Those benefits have now been increased to
>include the ability to writeoff losses beyond $3000 per year with a Section
>475 election. Traders do not give up the right to section 1256 treatment of
>their gains on futures contracts (60% long term) . It is only when the
>Section 475 election is made that the income becomes ordinary and the 60/40
>treatment is waived. The way around this is simply to start a new entity
to
>trade from once you make the 475 election (a Sub S Corp or LLC). Then you
>don't even have to ask the IRS for permission to revert back to a non 475
>entity -- you become one. (By the way Trader Status is a fully revocable
>election. You can be a Trader one year, and an investor the next without
>anyone's permission.)
>
> If a Trader has large expenses, or large losses in any one year, Trader
>Status 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 over a hundred
>thousand dollars on a single tax return.
>
> As I mentioned, some of the court cases you may want to reference the
>auditor to are:
>
>1) Snyder v. Commissioner (1935): Supreme court stated that taxpayer can be
>involved in the "business" of trading securities.
>
>2) Higgins v. Commissioner (1941): Supreme court ruled that whether or not
>the trading activities of a taxpayer constitute carrying on a business, an
>examination of the facts is required in each case.
>
>3) Fuld v. Comm (1943): Taxpayers held to be Traders because of a large
>number of trades, none of which were held for as long as two years.
>
>4) Commissioner v. Nubar (1951): It was held that the extensive trading of
>stocks and futures constituted engaging in a trade or business.
>
>5) Kemon v. Commissioner (1953): Court determined that Traders are sellers
>who take advantage of short term price fluctuations to sell at a gain over
>cost.
>
>6) Liang v. Commissioner (1955): Relevant considerations to Trader status
is
>intent of Trader to derive profits from a frequent trading.
>
>7) Reinach v. Commissioner (1967): Option writer did not have to prove this
>activity was a trade or business due to nature of instrument (options).
>
>8) Marlowe King v. Commissioner (1978): Futures Trader allowed to deduct
all
>expenses incurred with business of trading futures, even though some gains
>were long term. Trader's business of trading futures was upheld because of
>the nature of futures contracts.
>
>9) Levin v. United States (1979): A Trader is an active investor because he
>does not passively accumulate earnings, but rather manipulates his
holdings.
>A Trader's profits are derived through trading.
>
>10) Ropfogel v. United States (1992): US District Court (Kansas) determined
>criteria for Trader Status is comprised of six factors.
>
>These next few are cases in which trader status was disallowed, however the
>guidelines for what the requirements are were established. Note the issue
of
>Trader Status and the category itself was not denied, but rather its
>existence was reinforced, even though these specific cases were denied.
The
>courts just gave us more guidelines to follow:
>
>1) Purvis v. Commissioner (1976): Attorney denied status for failure to
file
>Schedule C.
>
>2) Moeller v. United States (1983): Despite full time management of
>securities and large investments, taxpayers were not Traders because their
>investments were long term.
>
>3) Frederick R. Mayer (1994): Trading advisors were objected to by IRS in
>determination of Trader status — courts never ruled on this issue. Trader
>status denied because advisors were investors.
>
>4) Rudolph Steffler (1995): Distinction made between "business" and
"activity
>entered into for profit." Substantial number of trades was key issue - the
>man had only 27 futures trades in 3 years!
>
> There are hundreds more. You just need to do a search on Kleinrocks,
BNA,
>RIA, CCH, or some other tax reference library.
>
> Good luck on the audit. If you qualify as a Trader, don't give up. I
will
>give you something. It is the magic word that makes auditors shrivel up
like
>vampires to a cross ( and because they don't often hear it, they will be
>somewhat surprised). That magic word is "NO". If they tell you they are
>moving your deductions to a Schedule A, tell them "NO YOU'RE NOT". I am a
>Trader, and I'm entitled to take them on my schedule C. Keep repeating it
>like a mantra. "NO...NO...NO". It works.
>
> Also, remember, the auditor has no right to change your tax return. He
>or she can only propose changes. You have to sign the form allowing them to
>do it. If you don't agree with the proposed changes, tell them you don't
and
>ask to speak to their supervisor. If the supervisor doesn't know what you
are
>talking about, and you don't agree, go to appeals. If what's at stake is
less
>than $10,000, you can go all the way to small claims tax court - by
yourself.
> It is your right as a taxpayer.
>
> Also, at each higher level, you have a greater chance of winning. The
>front line auditor's job is to make problems for you, their supervisor's
job
>is to resolve them. And, 66% of all cases that go to appeals get resolved
in
>the taxpayer's favor. You may want to consider having someone who is
>knowledgeable in this area represent you. It all depends what is at stake
in
>terms of money for you.
>
> Again I don't know what your situation is, so I am not telling you that
>you qualify as a Trader, but, if you want me to email a Trader
questionnaire
>to help you evaluate your situation, email me a tbtesser@xxxxxxxx
>
> And most of all...
> "Keep the IRS out of your pockets, and away from your trading
>profits!"
>
>Ted Tesser, CPA
>
>
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