If you are eligible for trader tax status (TTS), consider setting up a trading business to maximize tax benefits. Some traders benefit from an LLC; others don’t need one.
- Deduct trading business expenses.
- Elect Section 475 MTM for exemption from wash sales and the capital loss limitation.
- Be eligible for a 20% qualified business income QBI deduction on Section 475/TTS income.
- Deduct health insurance and high-deductible retirement plan contributions.
- Deduct state and local taxes (SALT) as a pass-through entity (PTE) business expense avoiding the $10,000 SALT cap.
How to be eligible for trader tax status
Volume: Make four trades per day, 16 trades per week, 60 a month, and 720 per year on an annualized basis (Poppe court). Count each open and closing transaction separately.
Frequency: Executes trades on nearly four weekly days, around a 75% frequency rate.
Holding period: In the Endicott court, the IRS said the average holding period must be 31 days or less. That’s a bright-line test.
Trade full-time or part-time. For a good portion of the day, the markets are open.
Hours: Spend more than four hours daily, almost every market day, working on the trading business — all time counts.
Avoid sporadic lapses: Once TTS commences, avoid lapses in the trading during the year. Trading must be regular, frequent, and continuous.
Intend to run a business and make a living. It doesn’t have to be a primary living.
Operations: Have significant business equipment, business services, and a home office.
Account size: Securities traders need to have $25,000 on deposit with a U.S.-based broker to achieve pattern day trader (PDT) status. For the minimum account size, we like to see more than $15,000.
What doesn’t qualify for TTS?
A third party creates the automated trading system (ATS) with entry and exit signals and mechanical execution. Some ATS don’t come with automatic execution, and traders significantly depart from ATS signals so that the trader can count those trades. A self-created ATS counts for TTS. Many traders come from the tech world and design and code an ATS.
A trade copying service does not count for TTS unless you depart from recommended trades significantly.
Engaging an outside investment advisor.
Trading in retirement funds.
Choice Of Entity
File a Schedule C with Form 1040
An individual TTS trader deducts business expenses, startup costs, and home office deductions on a Schedule C (Profit or Loss From Business – Sole Proprietorship) as part of the 1040 filing.
Traders don’t have revenue on Schedule C; they report trading gains and losses on other tax forms.
Schedule C expenses are an above-the-line deduction from gross income.
TTS Schedule C expenses also reduce self-employment income (SEI). However, trading income is not SEI unless you are a full futures exchange member per Section 1402(i).
Trading income is net investment income (NII) for the 3.8% net investment tax on NII over ACA thresholds.
Individual brokerage account
You can establish an individual brokerage account(s) in the trader’s name and social security number.
You can also use a joint individual account, but first, list the trader’s name and social security number.