Think you’re a trader? IRS may disagree

WSJ Tax article
Think You’re A Trader? IRS May Disagree



Even if you make hundreds of stock-market trades a year, that doesn’t automatically make you a trader — at least in the eyes of tax collectors. And that means you wouldn’t be eligible for certain breaks that traders can take.

This point is underscored by a recent Tax Court decision involving a Florida couple who formed a trading company and made more than 660 trades over two years. The court decided the couple were investors, not traders, and thus were subject to tough limits on deducting net losses and trading-related expenses.
[Go to tax court case]

* The Tax Court case
* IRS Tax Topic 429

While the Tax Court decision doesn’t break new legal ground, tax analysts say it shows how difficult it can be to qualify as a trader and emphasizes the line between individual investor and professional trader. Calling yourself a trader on your tax return isn’t enough, as the Tax Court decision points out. In addition to doing “substantial” trading with “continuity and regularity,” the Internal Revenue Service says you must also be trying to profit from daily market price moves.

“The decision shows it’s very, very difficult” to be considered a trader, says Bob Trinz, senior tax analyst at the tax and accounting business of Thomson Reuters.

Securities-industry officials say they don’t know how many traders there are out of the many people who buy and sell stocks and other securities. But in case someone thinks he or she has what it takes to be a successful trader and is tempted to try, the Tax Court case provides a reminder of how exceedingly tough it is to qualify based on tax law — and why the distinction can be so important.

“The court reminded taxpayers that it’s not enough just to call yourself a trader and to make numerous trades throughout the year,” says Tim Hanford, a tax consultant in Bethesda, Md.
[Trading-Stocks] Getty Images

The latest Tax Court decision, written by Judge Juan Vasquez, involves William Holsinger and Joann Mickler, who married in 1999. In 2000, they began buying and selling stocks from a room in their house, making about $280,000 that year, the judge’s decision said.

Early in 2001, the couple set up Alpha Trading Co. of Sarasota, Fla., and formally chose to be treated as traders, using what’s known as the mark-to-market method of accounting on their tax return. That generally means securities, whether actually sold or unsold, are considered sold at year end for tax purposes and give rise to ordinary income or losses. They had accounts with several firms. In 2001, they conducted about 289 trades. The following year, they executed about 372 trades. In both years, they had losses, which they deducted as ordinary losses as a trader would. The IRS decided they were investors, not traders, and that they owed about $98,000 in taxes.

As an individual investor, you can offset capital gains with capital losses on a dollar-for-dollar basis. But if your losses exceed your gains, you typically can deduct only as much as $3,000 a year of net capital losses. The limit is $1,500 for someone married and filing separately. Additional losses are carried over into future years. (There has been talk for many years of raising the annual net capital loss limits, but Congress hasn’t taken action.)

If you qualify as a trader and use the mark-to-market method, you aren’t bound by those annual net-loss limits, or by certain limits that apply to itemized deductions. “Traders can treat their losses as ordinary losses, rather than capital” losses, says David Hariton, a tax partner at the law firm Sullivan & Cromwell in New York City. But Mr. Hariton points out there also are drawbacks to being a trader: “They cannot treat their net trading gains as long-term capital gains eligible for lower rates.” (The top capital gains rate on long-term gains from securities sales is 15%, while the top federal income-tax rate on ordinary income is 35%.)

Judge Vasquez’s decision says a taxpayer’s activities qualify as “a trade or business” only if two requirements are met: First, your trading activity must be “substantial.” Also, you must be trying to catch “swings in the daily market movements” and trying to profit from these short-term changes, rather than from long-term holdings.

After studying the Florida couple’s records, Judge Vasquez decided that their trading activity wasn’t substantial. He said they traded on only 63 days in 2001 and 110 days in 2002. “We find it doubtful whether the trades were conducted with the frequency, continuity and regularity indicative of a business,” he concluded. The judge also ruled that the couple failed to prove they were trying to capture daily swings in the market and to profit from them. A list of their trades shows “they rarely bought and sold on the same day,” the judge said. Furthermore, he said, a significant amount of their holdings was held for more than 31 days.
[tax facts]

“We find that they were not traders, but investors,” Judge Vasquez wrote. “Petitioners’ trading pattern is consistent with that of an investor, not of a trader.”

The judge also concluded that trading-related expenses the couple had deducted as business expenses were subject to limits that apply to itemized deductions.

V. Jean Owens, a lawyer who represented the Florida couple, said he was “disappointed” by the decision. Mr. Owens said his clients haven’t yet decided whether to appeal.

The IRS offers more details in “Topic 429” on its Web site ( It cites various “facts and circumstances” that should be considered in determining whether your activity is a securities-trading business: typical holding periods for securities bought and sold; the frequency and dollar amount of your trades; the extent to which you pursue the activity to produce income for a livelihood; and how much time you devote to it.

The IRS points out the tax treatment of securities sales depends on whether a trader had previously chosen to use the mark-to-market method of accounting through what’s known as a “section 475(f) election.” In general, this “election” must be made by “the due date (not including extensions) of the tax return for the year prior to the year for which the election becomes effective,” the IRS says. You make it by “attaching a statement either to your income tax return or to a request for an extension of time to file your return.”
* * *

More stimulus payments flowed from the Treasury this summer.

As of the end of August, the Treasury had distributed a total of about 114.8 million economic-stimulus payments, the department said. Those payments totaled nearly $93.4 billion.

Those figures include about 2.4 million payments totaling $1.5 billion since July 11, the Treasury said.

The department also said Americans, especially seniors and veterans who don’t normally file tax returns, should file a return by the Oct. 15 filing deadline to receive a stimulus payment this year.
* * *

Senators back legislation to adjust charitable-mileage rate.

Under current law, you can deduct unreimbursed expenses, such as the cost of gas and oil, directly related to using your car to provide services to a charitable organization. You can deduct your actual expenses or use a standard mileage rate of 14 cents a mile.

Sen. Chuck Grassley, ranking member of the Finance Committee, is teaming up with several other senators in an effort to give the IRS the authority to adjust that 14-cents-a-mile rate, which now is set by law.

“People who volunteer for charity aren’t out to make money, but they shouldn’t lose a lot of money in the process,” said Sen. Grassley, an Iowa Republican. “Driving a car is more expensive than ever, and driving is critical to a lot of volunteer activities.”

Sen. Grassley says “it makes sense” to give the IRS “the flexibility to set mileage rates for charity work.” He notes that the IRS “already has the authority to set mileage rates for business, medical, or moving expenses.”
* * *

Interest rates will rise next quarter on underpayments to the IRS.

For example, the rate will increase to 6% on underpayments by individuals in the fourth quarter, the IRS says.

That’s up one percentage point from 5% this quarter.
* * *

BRIEFS: Reminder — Sept. 15 is the deadline for people who owe estimated taxes for the June 1-Aug. 31 period. … William J. Wilkins, a partner in the law firm of WilmerHale in Washington, D.C., takes over as head of the American Bar Association tax section, the nation’s largest group of tax lawyers. He will serve a one-year term and will be succeeded by Karen L. Hawkins of the Oakland, Calif., firm of Taggart & Hawkins.

About Jorge Costales

- Cuban Exile [veni] - Raised in Miami [vidi] - American Citizen [vici]
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