Trading Stock Options? Tax Advice

There is a distinct difference in labeling a person a professional trader or a hobbyist when it comes to stock options tax laws. The IRS will define you as a hobbyist if you do not consistently engage in stock trading activity. If your pattern of activity shows daily trading, then you can be considered a professional trader and qualify for specific tax advantages associated with conducting a business.

Who Are You?

Individuals who qualify as traders will receive certain tax advantages. The deductions can include your investment expenses, such as your home office, computer equipment and subscriptions to investment magazines and newsletters. However, you must fit the definition adopted by the IRS to qualify as a trader. A trader is someone who spends most days trading, has created a margin account and is a short-term investor. If you do not fit into a "trader" category, you will be considered an "investor." An investor is a hobbyist. The IRS does not allow
the hobbyist deductions for computers, subscriptions, and so on.

What Is a Trader?

  • Amount of time spent trading determines if you a trader or investor. According to the IRS, the number of days of trades are compared to the total number available for trading. If you meet the requirements, typically 45 percent, you are considered a trader.
  • In order to be a trader, you must have an established margin account used for pattern trading. A margin account is an account that holds funds for trading. Typically, margin accounts can range from $25,000.00 to $50,000.00.
  • Trading activity is in the form of several trades made daily.
  • Your profit goals include mostly short-term gains as opposed to long-term investing. The trader's average holding period of a stock significantly shorter than an investor.

Take a Test

Court cases have been heard where a definition has been established selecting a minimum amount of time as the basis for determining the nature of trading activity. For example, if you spend only 10 hours per week and make 200 sales per year, you will be labeled an investor. However, you can qualify with “part time” activity while holding down another job if you spend 20 hours per week making a minimum of 1,000 short-term trades in a given tax year. The IRS will accept this. Additionally, a 30 hour per week activity making 5,000 annual trades will definitely fall under the IRS definition as a professional trader allowing you all the tax advantages associated with conducting a professional business. You can act as both an investor and a trader as long as your long-term holdings are separate from your short-term activity.

What’s the Reward?

Once qualifying as a trader, from the IRS point of view, you qualify as any self-employed individual does, allowing all investment expenses to be deducted on a Schedule C form. Investors must use a Schedule A form that limits the amount of the expense deductions to 2 percent of adjusted gross income. Traders can deduct the exact costs for all trading activity. Additionally, all margin account interest can be deducted on Schedule C.  Immediate deductions of up to $250,000 can be realized for any equipment you use in trading activities such as computers, fax machines, telephones, copiers and office equipment. They are termed as Section 179 deductions, or home office deductions. This deduction is allowable as long as its use does not produce a net loss situation. Another advantage is that no self-employment tax is paid since capital gains are tax exempted.
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