The term Trader Status is used frequently among the trading community. But what does this exactly mean to the Active Trader? According to IRS Topic 429 in order to qualify for Trader Tax Status you must meet the following conditions:
-You must seek to profit from daily market movements in the prices of securities and not from dividends, interest, or capital appreciation;
-Your activity must be substantial; and
– You must carry on the activity with continuity and regularity.
Pretty boiler plate at best right? To take it a step further the IRS has established the following criteria:
– Typical holding periods for securities bought and sold;
– The frequency and dollar amount of your trades during the year;
– The extent to which you pursue the activity to produce income for a livelihood; and
– The amount of time you devote to the activity.
Trader Tax Status drives many key business tax breaks like business expense treatment and ordinary income/loss treatment with a Section 475 (Mark-to-Market)election. If an active trader elects to trade through an S-Corporation Entity they can also unlock employee benefit plan deductions for retirement and health insurance premiums. All deduction items are allowed to be deducted from gross income without limitation.
How to Qualify
The wonderful and complicated issue with Trader Tax Status is that there is no bright-line test. There is no application or endorsement for Trader Tax Status. The best way to determine qualification is look at past case law studies and the outcomes reached by the courts. Based on our research of past court cases we’ve identified some Active-Trader parameters in the event a trader had to defend him or herself in Tax Court. We like to say that in order to qualify for Trader Status an active trader must B.E.H.A.V.E.
B – Business Expenses customary to a trader (i.e. News Feeds, Data Level 2 Feeds, Chat/Educational Services, and Office Space)
E – Equipment used for trading such as computers and multiple monitor set-ups.
H – Hours 4 or more hours per day including research and administrative tasks.
A – Average holding period not to exceed 31 days
V – Volume of trades at least four or more trades per day with at least 15 or more for the week. Note that a round-trip trade (buy and sell) would be considered two trades.
E – Extent of Activity must be at least 75% of the available trading days. On average 4 out of 5 days per week must have a trade execution.
In addition to our BEHAVE parameters a trader must possess the motive to run business and make a living. You must trade your own capital (ideally above Pattern Day Trader Requirements of $25,000 but not a deal breaker). It does not have to be your primary means of making a living but the motive for trading is to be successful and make money. If you have additional sources of income the best way to prove your legitimacy is through the establishment of a trading entity (Partnership, LLC, or C-Corp). Note that trading in retirement funds does not qualify for trader tax status and should be shielded separately of a trader’s business activity.
We don’t advise going it alone. If you make one mistake, the IRS can deny your trader tax status or mark to market election, costing you thousands of dollars in lost deductions. A good way to get started with our firm is to schedule a 30 minute consultation to asses your situation.
We can help you with the following services:
- Establishing trader tax status
- Electing mark to market (IRC Section 475) & filing out the appropriate forms
- Trader entity consultation
- Trader Entity Formation
- Trader Tax Preparation
- Tax Planning to maximize your deductions
