Page 3 ~ Is Your Client an INVESTOR? a TRADER? or a MARK-TO-MARKET TRADER?

TaxMama.Com
Tax Information With A Mother's Touch

Published by Eva Rosenberg, MBA, EA

goedeckebio

About the author: NANCY E GOEDECKE, EA

Nancy E Goedecke, EA is a full-time practicing Enrolled Agent specializing in individual and small business taxation. She is an experienced teacher and a frequent presenter of income tax seminars for professionals across the country.

Nancy is known for her ability to make comprehensive tax issues understandable and applicable in daily practice of attendees. She became an EA and joined NAEA in 1986, is a Fellow of the National Tax Practice Institute and currently serves as Secretary of NAEA. She is also a member of the Internal Revenue Service Advisory Council (IRSAC) which meets at the national office of IRS with Commissioner Rossotti and his staff.

She is a Past President of the Massachusetts Society of Enrolled Agents and recipient of the 1989 "Enrolled Agent of the Year" award. As owner of Taxes & Money Management in Hudson, MA, Nancy is also a Registered Representative / Advisory Representative orchestrating comprehensive financial solutions to her clients.

Is Your Client an INVESTOR? a TRADER? or a MARK-TO-MARKET TRADER?
~ by Nancy E Goedecke, EA ~

Page 3

WHAT'S THE REWARD FOR QUALIFYING AS A TRADER?

According to tax law, traders are in the business of buying and selling securities. This means the trader is self-employed and may deduct all of his (her) trading expenses on Schedule C, like any other sole proprietor. These would include margin account interest, computer expenses, Section 179 expensing for equipment used in the trading business, and perhaps even home office expenses. Here, unlike the Investor who is subject to limitations and phase-outs on Schedule A, 100% of the expenses are deductible and could even create a net operating loss.

The trader still reports all transactions on Schedule D, and any profits from the sale of capital assets are exempted from self-employment taxes. Deductible net losses are limited to the statutory maximum of $3,000 per year, with the excess being carried forward. Since all the trading activity is reported on Schedule D and all expenses on Schedule C, we recommend attaching a statement to the return to explain and reconcile the odd appearance.

Any gains are short term, and thus are taxed at ordinary income rates. Unfortunately, if there is a net loss, STCL rules limit the deduction to $3,000 ($1,500 for married filing separately) in any single tax year. The balance can only be carried forward and will offset future capital gains and the remaining excess deducted at the maximum $3,000 per year.

Example:
Sam has a $100,000 STCG with a $40,000 STCL in 2000. The net gain of $60,000 is taxed at ordinary income rates. However, in 2001, Sam has a $40,000 STCG and $100,000 STCL, producing loss of $60,000. Sam cannot carryback his 2001 loss to 2000 to offset the taxable gain that year. Instead, he receives a $3,000 ordinary loss in 2001 and must carry forward the $57,000 balance to future years. If Sam does not have gains in future years, he would exhaust his STCL in 19 years. ($3,000 x 19 = $57,000).

HOW IS A DEALER DIFFERENT FROM A TRADER?

A trader, even one who makes trading his career, isn't a dealer.

A dealer is a merchant, a middleman whose business, licensed in the securities industry, is to buy securities in quantity and resell them to his customers, usually at a markup. He looks to his markup or fees, rather than to the changes in the market, for his profits.

Traders, on the other hand, depend on fluctuations in the market for their profits. Traders do not hold inventories of securities, and those who buy what a trader sells are not his “customers”. As the courts have stated, while “both dealers and traders may be engaged in a trade or business, only a dealer has customers.”

By definition, all securities, except those held for sale to customers, are capital assets. Thus, transactions as a trader result in capital gain or loss, while sales by a dealer out of his inventory generate ordinary income or loss. The dealer is subject to self-employment tax on his Schedule C profit, but the trader is not subject to SE tax on the sale of his capital assets on Schedule D.

Another striking difference is the way in which losses are treated. Dealers are exempt from the wash sale rules which bar traders and investors from deducting losses on sales of securities if they buy substantially identical securities within 30 days before or after the sale. A dealer's current net losses may create a net operating loss which can be carried back to offset earlier years' taxable income, but an investor or trader's losses are limited to $3,000 in the current year with any excess being carried forward to future years.

« Previous «

» Next »

Certain graphics on this site were created especially for TaxMama by Serenata of Serenata Design. Site design & maintenance by Serenata Design.