|
PureBytes Links
Trading Reference Links
|
This is an excellent post, but I have a question for both you and the
group. One of the rules of trader status is frequency of trades and the
other is duration. Now I am a professional trader, that is what I do, but I
rarely make more than 2-4 trades a month and I generally hold for 4-7
days--thats it. To me (just my trading style group) being in the market is
the most risky element of trading, I get in and get out according to my
trading system.
The question is, is the government saying you have to be a commission
generator qualify as "trader" status. Why should it matter how often I
trade, or the duration of my trades. Warren Buffet doesn't trade that
frequently???
MM
This is very interesting to me, please feedback with all comments
-----Original Message-----
From: TBTesser@xxxxxxx
To: omega-list@xxxxxxxxxx
Cc: realtraders@xxxxxxxxxxxx
Sent: 9/16/99 12:42 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
|