Page 4 ~ Is Your Client an INVESTOR? a TRADER? or a MARK-TO-MARKET TRADER?

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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 4

MARK-TO-MARKET TRADERS — RRA97 & Rev
Proc 99-17

Those who qualify as Traders may take advantage of a recent tax law change that allows Traders to elect “mark-to-market” accounting. Two important tax benefits result:

First, the wash sale rules do not apply, and
Secondly, the trading profit or loss is considered “ordinary” and is therefore exempt from the $3,000 annual deduction limit on net capital losses.

Here's how it happens:
On the last trading day of the year, the mark-to market trader must for accounting purposes “sell” all holdings at fair market value to book the imaginary gains and losses as of that day for tax purposes. This means (s)he begins the new tax year with no unrealized gains or losses and the new basis of the retained securities is year-end fair market value. The net gains or losses on the transactions are reported as ordinary income or loss and as such are not subject to the capital loss restrictions.

Net earnings from self-employment does not include gain or loss of a securities or commodities trader that is treated as ordinary income solely by reason of the mark-to-market election (IRC §475 (f) (1)(D)).

Example
During the tax year 2000, Sam as trader, had $200,000 of STCG and $300,000 of STCL. If Sam failed to elect mark-to-market accounting, he would report his gains and losses on Schedule D. His net STCL would be $100,000. Sam could deduct $3,000 in 2000 as an ordinary loss and carry forward $97,000 in losses to future years.

In contrast, if Sam had elected the mark-to-market treatment, he would report his year 2000 transactions in Part II of Form 4797 netting $100,000 in short term ordinary loss. This loss flows to Form 1040 and is applied to other income, perhaps creating an net operating loss.

Furthermore, under the net operating loss rules, Sam could carry forward the unused loss for 20 years, or carry it back for 2 years, then forward from that point (subject to the 20-year carryforward limitation).

The 2000 Form 4797 Instructions provide guidance for the trader in securities with a mark-to-market election under IRC §475(f) in effect for the tax year.

A summary follows:
Gains and losses from all securities or commodities held in connection with your trading business (including those marked to market) are treated as ordinary income and losses. As a result, the lower capital gain tax rates and the limitation on capital losses do not apply. The gain or loss from each security or commodity held in connection with your trade or business (including those marked to market at the end of the trading year) is reported on Form 4797, line 10. The wash sale rule does not apply.

Attach to your tax return a statement, using the same format as line 10, showing the details of each transaction. Separately show and identify securities or commodities held and marked to market at the end of the year. On line 10, enter “Trader - see attached” in column (a) and the totals from the statement in columns (d), (f), and (g). Also enter on line 1 the total gross proceeds from sales of securities or commodities reported to you on Forms 1099-B (or substitute statements) that you are including on line 10 as a mark-to-market trader.

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