Frog Trader 101 series (2) Trader Tax Status with Mark to Market Accounting

bobcat

by THE CAT

Reading this article will save an active trader at least $10,000 a year in taxes.

Trader Tax Status with Mark to Market (MTM) accounting should be considered by all traders
for the following reasons:

1. You may deduct your entire loss on trading against any of your other incomes. You may even elect to deduct against
your past income in the prior two years. This means if you paid taxes in the last two years but lost money in trading
this year, you may ask for a refund from IRS. Other traders are limited to deduct $3,000 a year for the losess.
Consider the following senario:

In 1999, a trader made good profit from internet stocks and paid IRS $3 million in Tax. However, in 2000, he lost $6 million,
about 97% of his money in stocks and he decided to quit trading. Then by IRS tax code, he would deduct $3,000 a year. It
would take more than 2000 years before $6 million deduction is finally made!
Should he be under trader tax status with MTM, he would reclaim the $3 million he paid to IRS in the previous year and trade on.

In this way, Trader Tax Status with MTM may be viewed as an insurance against losses. Even if you are an experienced
trader and you believe that you will never lose money from trading, you may still have a sudden loss for other reasons, such as
the collapse of your brokerage houses, your clearing houses, a war, etc..   

2. You may claim deductions for home offices, computers, part of home utilities, newspapers, cable services, housekeeping, etc..
These deductions are calculated within you gross income and therefore there are no floor or ceiling
or any limitations for them. You get these deductions even when you lose money in trading!

3. You don't have to worry about wash sales.

4. You may choose inventory method for filing so that you don't need to match each trade.

5. Although under MTM, there is no long term gain, you may still use different accounts for regular accounting for long term investments.
I suggest you choose regular accounting for futures and forex accounts, because 60% of the
gain from futures and currency trading is considered as long term regardless the length of holding.

Many people think that it is difficult to qualify for trader tax status. My observations through a few friend traders tell
otherwise. You may have a chance to qualify if
(a). You make over 300 trades a year.
(b). A nice percentage, say, 30% of your income is derived from trading for the last couple of years.
Bear in mind that there is no clear rule for the qualification. Item (b) is not even a rule, but it gives you more chance
to be approved. If you have lost money every year, IRS would say that your trading activity is a hobby, not a business,
and you might be disapproved.
Even if you don't believe you qualify, you may always try. If you trade full time, you almost always qualify.
For example, if you work and your spouse stays at home, then your spouse may claim as a full time trader.
If you fail, you may try next year. You only have to be approved once.

To apply for trader tax status with MTM, you need to apply a year in advance, together with your return. Your local accountants
may not know how to file properly, but you may do it on your own by reading the well written book
"The Tax Guide for Traders" by R.A. Green. The book provides many samples that you may choose from.
Good luck!

benshou

Good One. Thanks!