As an investor or trader, there are three trader tax statuses that you will fall under. With the new tax code, your trader tax status with the IRS will dictate how you are taxed and more importantly, how much you will be taxed.
Understanding what trader tax status you should have can be the difference in saving thousands of dollars every year in taxes. Here is a breakdown of three three trading statuses with the IRS and how you can save a ton of money with the right structure.
Trader Tax Statuses
Default Trader Status
Default Trader Status is the default tax status that is given to traders initially. This status is designated for traders in the market that do not have an established trading entity. It is categorized by the IRS as a “Hobby Trader”. This status is good for individuals who are looking to make a few investments yearly but do not plan on making very much in profits.
With the change in the tax code as of 2018, “Hobby Investors” cannot deduct business expenses or expenses that are directly related to the market or their investment activity.
Active Trader Status
As of the 2018 tax code changes, in order for investors to take any tax advantage from their investment activity, they must qualify as an Active Trader or Investor.
In order to do so, they must meet a litany of requirements. Most investors fail at least one of the following.
1) Must trade continually in the markets ( no breaks);
2) Must have a specific volume of trades per month,
3) Must derive a majority of their income from their investment activities.
Individuals who meet these requirements also must file an election with the IRS on an annual basis to even receive the status.ly related to the market or their investment activity.
Active Investor Status is very hard to qualify for.
Self Employed Trader Status
With Self Employed Trader Status, Investors can take itemized deductions for business expenses, itemized deductions for costs directly related to the market (commissions, software, etc.) and capture the max portion of capital losses. If you trade out of a cash account, you should have Self Employed Trader Status. It will save you thousands of dollars every year.
Alternatively, the IRS has allowed individuals to obtain Self Employed Trader Status through a specific type of business entity structure to take tax business deductions, without qualifying as an Active Trader.
This is more beneficial because the business does not have to make an annual election and therefore comes under less scrutiny.
With the new tax code, it is imperative that you are structured the right way. The new tax code offers many benefits to those operating as a business with the correct tax status. Make sure you can take advantage of all of the deductions that are available to those with the correct status and structure. Remember… It’s not what you make, it’s what you keep.