One of the great things about trading is that all you have to do to become a trader is get started. Many people trade as a hobby, while others trade full-time to make a living, and then there are some traders who fall somewhere along that spectrum with their activities.
Depending on how much and how often you are trading, you may be able to reap certain benefits when tax time comes around. If you’re a serious, dedicated day trader, then claiming active trader tax status is your best option for maximizing your deductions and minimizing your losses. But how do you qualify for this elite tax category? Let’s take a look.
To qualify for active trader tax status, you must meet the following requirements in the eyes of the IRS:
1) Seek profit from daily swings in the prices of securities
Those who claim active trader tax status must intend to benefit from short-term market movements, rather than long term holds/investments. This criterion was established in the 2015 court case of Poppe v. Commissioner of IRS. The court ruled that William Poppe could claim trader tax status, and the benefits that come with it, as his volume of trading (approximately 60 trades per month) reflected an intention to profit from short-term price swings.
2) Trade substantially, frequently, and continuously
To be considered a part-time or full-time trader, you must spend at least four hours trading per day on almost every market day. Time spent doing research, completing related administrative work, and any travel for meetings or education all count toward this quota, in addition to time spent buying and selling trades, of course. You can have a few days off here and there, just like any job, but you can’t be taking off for several weeks or months at a time if you want to qualify.
3) Intend to make a living from trading activities
Trading doesn’t have to be your only source of income for you to qualify for active trader tax status, but it does have to be a primary one. You must operate with the intention to trade as a business, using your own money as trading material, or otherwise demonstrate that you’re serious about trading. To verify, the IRS may look for you to have significant business equipment, such as educational resources, software, and a dedicated office at home or elsewhere.
Other Types of Trader Tax Status
Traders that meet the above requirements can qualify for active trader tax status and receive favorable tax benefits. Additionally, active traders can qualify for pattern day trader status if they have a $25,000 deposit with a U.S.-based broker. However, active trader status is not the only way the IRS categorizes trading activities.
Most traders fall under default trader status, which means they do not have an established trading identity and are considered “hobby traders”. Default traders cannot deduct business expenses or any expenses directly related to their investment activities. The other status a trader can qualify for is self-employed trader tax status. This status is usually ideal for incorporated traders, or anyone who is using a cash account for their trading activities. Benefits include claiming additional itemized deductions and capturing the maximum portion of your capital losses.
How to File for Trader Tax Status
The IRS requires you to notify them ahead of time before you can file claiming active trader status. You must do this by providing them with a tax return from the previous year, Form 4868 (the Application for Automatic Extension of Time to File U.S. Individual Income Tax Return), and a written intention to make a mark-to-market election under section 475(f) of the Internal Revenue Code.
The process of qualifying for active trader tax status can be tricky. Your best chance at success is to enlist a professional trader tax specialist to help you. The expert consultants at Trader’s Accounting offer a variety of tax services for individuals and businesses who are active in day trading, including tax planning, tax return preparation, business entity formation, and more.
To learn more about which of our services will help you maximize your trading profits, give us a call at 800-938-9513 today!