I'm looking into exactly what it takes to achieve the exalted trader status and unlock the associated tax benefits. If I understand Robert Green and other experts correctly, trader status requires the following: 1) Execute 4 or more trades per day, holding each position for no more than a month. 2) Do step 1 four or more days per week, avoiding lapses in trading activity. 3) Trade during a span of at least 4 hours on those four or more trading days per week. 4) Losses should not exceed wins in number. Those are a lot of criteria to meet! There's no way I could achieve this with my normal trading approach. I'm wondering if anyone has any experience engineering strategies to hit all these points. I've thought of an idea, but am not sure if the IRS will go for it: Program an automated system (through Sierra Chart or some software like that) to buy 1 share of an inexpensive commission-free ETF once every hour during the trading day. Place the orders with attachments to liquidate at a limit price of 1 tick profit. Close any open positions, eating the occasional loss at the end of 30 days. Alternatively, one could do the same thing but with an inexpensive option contract that expires within 30 days. That isn't commission-free, but the cost of placing these cheap option bets is less than the normal tax burden without trader status. It seems to me that would meet the standards for trader status without costing much or anything. But will the IRS buy this? It seems pretty obvious that this is shameless fenagling (admirable if achieved with impunity, as Edgar Allan Poe says).
Tax burden is the same. Only difference is marked to market (no wash sales) and ability to offset current losses with past gains (but you can do that now with 1256 contracts).
Thank you for the input. MTM election does strike me as a pretty nice. The wash sale loss rule has cost me $10s of thousands in extra taxes: I dutifully cut my losses and got right back in on the same 1 or 2 pet tickers only to realize later that those losses weren't subtracted from my subsequent gains in those stocks. I'm still dumbfounded that this rule exists at all. Another benefit of MTM is that loss deductions don't stop at $3000. In the event one loses, say, $30,000 trading, all of that is deductible from other taxable income upon taking the MTM accounting election. That's quite a savings on your day-job gross income, which is at least a silver lining to trading losses. As for 1256 contracts, I've been trying for years to get an edge in futures and don't know how. (That's a whole other thread.) Some high beta stocks and ETFs ought to be 1256, as they're no more holdable than a futures contract, but I don't make the rules. Another benefit to trader status is the ability to take deductions on expenses related to trading, such as a home office, hardware and software, educational field trips, interest on money borrowed for trading on margin, etc. And if it's your corporation that has the status, the corp can deduct health insurance and retirement contributions paid to the individual trader. So it seems like there are quite a number of significant benefits, unless I've misunderstood the subject.
that’s all good points. Wash sale only affects you when you cross a calendar year. I thought about trader tax status when I had 1mm of losses defferred two years ago. I had forgotten about the deductions because I have other avenues to deduct my trading expenses which are small (really just a computer and some market data)
The conditions you have listed are a set of guidelines. They may flow from case law, i.e., disputed audit cases where the federal courts had to decide whether someone was a trader. Or they may come from IRS procedural manuals that are used by auditors. But they are still just guidelines. You won't find those specific conditions anywhere in the text of the Internal Revenue Code. The determination of whether you are a trader for tax purposes is based on all the relevant facts and circumstances. You should take a look at the criteria in IRS Publication 550, which I have attached. See the section called Special Rules for Traders in Securities or Commodities, on page 68. When you take the position that you are a trader, you don't have to submit any specific documentation to the IRS unless you get audited and they challenge your status as a trader. If you use a tax professional, you do have to convince them that you meet the IRS criteria, or they may refuse to do your taxes the way you want. But the criteria in Publication 550 are very flexible, and open to interpretation. If you DO get audited, what you are proposing--an automated system that would trade one share every hour--is likely to backfire. That kind of activity does not demonstrate that you are seriously seeking "to profit from daily market movements," which is one of the IRS requirements. Automated trading of just one share shows only that you are trying to check off certain boxes, i.e., you are putting form over substance, and that you are NOT seriously trading as a full-time business. To the extent that the criteria you listed may actually be used by the IRS in some audit cases, automated trading of only one share would likely be interpreted as a sham, i.e., that you are complying with the letter of the guidelines but not with the spirit or the intent. That kind of trading does NOT show that you are "in the business of buying and selling securities or commodities for your own account." It shows that you are trying to check off some bullet points that you found on a website, or that your accountant gave you. Publication 550 says that "your activity must be substantial," and that the IRS will consider "the dollar amount of your trades during the year," and "the extent to which you pursue the activity to produce income for a livelihood." Trading one share every hour does not satisfy those criteria. BMK
Thank you. Yes, what I was suggesting is clearly just checking off boxes. And the whole matter is largely subjective rather than neatly stipulated in the tax code, which means the trading strategy has to be reasonable. Frequently buying out of the money calls on the Vix as an inexpensive way to profit from unforeseen spikes in volatility is probably more plausible than buying a single share of some ETF, especially in a year like this one where those OTM calls really performed. I wonder if that strategy seems more in line with the spirit of this tax treatment.
If you're an equities trader minimum 720 trades per year, 31 days or less duration and trading must be your main source of livelihood... ps these conditions are as per two Supreme Court cases....
There is no simple answer to that question. Here's the relevant text from IRS Publication 550: Self-employment tax. Gains and losses from selling securities or commodities as a trader are not subject to self-employment tax. This is true whether the mark-to-market election is made or not. For an exception that applies to section 1256 contracts, see Self-Employment Income, earlier. Self-Employment Income Gains and losses derived in the ordinary course of a commodity or option dealer's trading in section 1256 contracts and property related to these contracts are included in net earnings from self-employment. A section 1256 contract is any: •Regulated futures contract, •Foreign currency contract as •Foreign currency contract as defined in chapter 4 under Foreign currency contract, •Nonequity option, •Dealer equity option, or •Dealer securities futures contract. A section 1256 contract does not include certain swaps as listed in Exceptions under Section 1256 Contracts Marked to Market in chapter 4. BMK