Introduction to Trader Status
Overview of tax issues for securities traders.
If you engage in a great deal of short-term trading, you may want to consider filing your tax return as a trader. Doing so is likely to reduce your taxes — in some cases by a large number — but may also create some audit risk.
Are You a Trader?
The word trader has a special meaning in the tax law. It refers to someone who trades to catch short-term swings in market prices (not long-term appreciation or dividends and interest), and does so in a large enough volume, consistently over a long enough period of time. The biggest problem with trader status is the absence of a clear definition. There are no precise standards telling us when trades are considered short-term, or how large a volume you need, or how long a period you must continue the activity to be considered a trader. Sometimes it's easy to determine that someone is or is not a trader, but in many cases the answer isn't clear.
Tax Benefits
If you're a trader, you're likely to be able to claim more deductions
than an investor. Some deductions that would be claimed as itemized
deductions subject to various limits will be allowed as business
deductions, without such limits. And there are some deductions traders
can claim even though investors can't claim them at all.
In addition, traders are eligible to make the mark-to-market
election. If you make this election, your trading losses won't be
subject to the $3,000 capital loss limitation. This limitation can be
very painful for a trader who has a bad year.
Filing as a Trader
If you're a trader who has not made the mark-to-market election, your trading expenses go on Schedule C, the form used to report business income and expenses. But your trading income is capital gain, and has to be reported on Schedule D. This looks very strange indeed to tax professionals who are not familiar with trader filing, but this is how it is done.
Mark-to-Market
Traders are eligible to elect a special method of accounting called the mark-to-market method. All securities traders should at least consider making this election.
Caveat Lector
I don't claim to have a monopoly on good information about this subject. I make mistakes just like anyone else, and some aspects of trader status are fuzzy enough to leave room for reasonable minds to disagree. Be warned, though: there are more urban legends about trader status than there are about pets and microwaves.
More Information
There's much more information online in the following pages, and additional detail in our book, Capital Gains, Minimal Taxes.
