“How I Turned My Frustration With the Schedule D Into a Tax Break I Could Drive My SUV Through”
If you are a trader and you want to reduce your taxes, there are issues potentially worth many thousands of dollars to you that you need to consider right away. In this article we are going to be guiding you painlessly through the main artery of the 1040 tax return, the often talked about, heavily detested, Schedule D. In this article:
We’ll show you how to wash away your concerns over wash sales
How to qualify as a “trader in securities” and deduct all your trading expenses
And, how to file a mark-to-market election, allowing you to offset your W-2 income with 100% of your trading losses, instead of the $3,000 capital loss limitation.
The Schedule D
First of all, what is the Schedule D? It is the part of your 1040 where you record all of your stock sales. Actually, you can use it to report a fairly wide variety of collectibles, such as art, antiques, rugs, and jewelry. For the purpose of this article, lets presume you are a trader of stocks, options, or other securities.
The Schedule D is divided into two parts. Part I: Short-Term Gains and Losses and Part II: Long-Term Capital Gains and Losses. A short-term holding is a position held less than one year. A long-term holding is a position held more than one year. The day after you received the property is the first day you count, and the last day is the day you sell or otherwise dispose of the position.
The tax rate for short-term gains is the same as your ordinary income rate. The tax rate for long-term gains ranges from 10-20% depending on your income. As there is a significant difference between the highest ordinary income rate of 39.1% and the 20% long-term rate, it pays to track your positions closely if your have a gain and are approaching the one-year mark.
The Wash Sale
One nasty piece of IRS work is the wash sale. In short, you need to pay attention if you move in and out of the same stock or option throughout the trading year. If you sold your security at a loss, and, within 30 days before or after the sale or disposition, you buy the same stock or option again, you cannot deduct the loss. Instead, the basis of the same position is increased by the amount of the disallowed loss.
The wash sale can be a record keeping nightmare, especially when you carry over your positions from one tax year to the next. One simple way to wipe the slate clean is to stop trading any positions in December that you have traded at a loss during the previous 60 days.
Traders Pay Less Taxes
Let’s all repeat together, “Traders Pay Less Taxes, Traders Pay Less Taxes, Traders Pay Less Taxes.”
Are you a “Trader in Securities?” That’s the first step in paying less taxes.
A Trader, in the eyes of the IRS, is someone engaged in the business of buying and selling securities. The IRS has outlined a threshold of trading that you must meet in order to qualify as a Trader. They have written that you must “seek to profit from daily market movements, with substantial activity, carried on with regularity and continuity.” Unfortunately, this definition raises more questions than it answers. If it wasn’t for ambiguity though, what would the lawyers and tax courts do all day, anyway?!
So, back to our Mantra, “Traders Pay Less Taxes.” We don’t have the space here to cover this in detail, but here is the gist of it:
Traders can deduct all business expenses, as long as they are ordinary and necessary
Traders can deduct fringe benefits such as medical, travel, and entertainment expenses
Traders can have their losses characterized as ‘ordinary’ rather than ‘capital’ and avoid the $3,000 Capital Loss Limitation.
In order for Traders to report all gains and losses from their trading business as ordinary income (or loss), they need to file an election with the IRS, called the Mark to Market Election. The election needs to be filed by the due date of the previous year’s tax return (without extensions). That means that if you want to be a Trader, you need to make that decision before you file your taxes this year. There are other issues to consider before electing Mark to Market, so we strongly suggest you contact Traders Accounting prior to doing so.