For most people, taxes can be a headache. This is especially true for investors who are not quite certain what they qualify for, how they need to report, or what tax benefits they can take advantage of. If you’re not careful, the IRS can classify you as an investor, which can have harsh consequences on your cash flow and punitive damages if you report incorrectly. On top of all of that, tax laws are constantly changing and evolving.
If you trade, it is essential to know how to navigate the IRS and keep as much money in your pocket as possible. Benzinga met with Jerry Allison, a CPA for Trader’s Accounting, to share his tips about how to do your taxes as an investor. Here’s what he had to say.
Think Of Yourself As A Business
For any company or business endeavor, your number one concern should always be protecting and generating your cash flow. Taxes are an essential part of this equation. The overarching problem most day traders need to avoid is the IRS considering you an investor for tax purposes. An investor will be hit with more regulations, as well as limits on deductibles whereas, being qualified as a trader has many advantages with few disadvantages.
So how do you qualify for trader tax status? Like anything tax related, it can be a bit complicated. The IRS does not denote specific, concrete rules under its Qualification 550 form, but courts have created precedents that define how traders can qualify for Trader Tax Status (TTS). These are the current qualifications:
- The holding period is short-term, less than 31 days
- Trading occurs 75-80% of the trading days per year and a trader has 700+ trades/year and 500 hours of trading or trading-related (like courses) activity
- The intent is to make a living, either solely or supplementary
If you fit these criteria, you can qualify for TTS on Schedule C on your personal taxes. However, Schedule C is the most scrutinized and audited classification by the IRS. Jerry recommends to many of his clients that they form an LLC, or trading business, to truly take advantage of taxes and distance themselves from the scrutiny of the IRS. He believes that being audited and risking a court case with the IRS is a risk everyone should avoid.
Becoming an LLC serves as quasi-insurance against the IRS. Yes, LLCs cost money to form and maintain but protecting against potential audits is worth the cost, in Jerry’s expert opinion. LLCs also provide flexibility in how you file your taxes. As an LLC, you can file under Schedule C, S Corporation, C Corporation, multiple-member LLC, and even take advantage of mark-to-market election.
It is important for traders to remember that each person’s tax situation is unique and to make the most out of taxes, getting professional opinions and help is often the best way to go. And Jerry’s biggest piece of advice? Keep a record of anything and everything so you’re covered no matter what happens.
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Photo by Kelly Sikkema on Unsplash
