By: Montana Timpson
When it comes to trading status, professional traders have several options: they can trade as individuals, qualify for trader tax status or trade through a business entity.
The latter — forming a legal trading business — is a great option for professional traders seeking beneficial tax treatment and asset protection. Here’s what you need to know.
Trader tax status (TTS) is a qualifying rank that, when met, constitutes fortuitous tax benefits for qualified traders and additional business expense advantages for qualified corporate entities. Before incorporating as a business trading in securities, traders must ensure eligibility to qualify for TTS advantages, as TTS is not automatically granted upon incorporation as a business entity.
To be eligible for TTS, a trader must meet various conditions set forth by the Internal Revenue Service (IRS). The conditions are as follows:
The following circumstances are often cited as additional considerations:
Weighing the Options
If a trader meets all IRS trading benchmarks the tax laws require (noting that even then, individual TTS verifications remain at the discretion of the IRS), the trader can choose to remain an independent qualified trader or incorporate as a business entity. While fiscal and filing options are similar for the two, trading as a business can offer additional, considerable tax advantages.
Professional traders trading as a business entity can opt to incorporate as a sole proprietorship, partnership, S-corporation, or a limited liability company (LLC), with varying benefits to each structure.
Note: Professional traders can have investment accounts that are treated according to the usual tax rules that apply to investments, but they must be identified as such on the day that the security is acquired, most often done by keeping investments in a separate brokerage account. Investing, in the eyes of the IRS, is a practice where expected income stems from dividends, interest, or capital appreciation, and is barred from definition as a trade or business.
Fiscal and Filing Advantages for Businesses
Under a sole proprietorship, partnership, S-corporation or LLC (taxed as an S-corp), TTS traders can deduct trading business expenses, startup costs and home office deductions. All four business entity structures allow for the election of IRS Section 475 on securities for tax loss insurance and offer a potential qualified business income (QBI) deduction. Under an S-corp or LLC, TTS traders can deduct health insurance premiums and retirement plan contributions and are often exempt from Social Security and Medicare taxes on business income.
Under IRS Section 475 guidelines, qualified traders can employ mark-to-market (MTM) accounting — a method under which there are no reported long-term capital gains or losses (since all open positions must be marked to market by yearend) and the sales of individual securities do not have to be reported; instead, the trader reports the account values at the beginning and end of the tax year to determine profit or loss. Professional traders who apply MTM accounting methods are advantageously exempt from adhering to IRS wash sale rules —rules that prevent ordinary taxpayers from deducting a capital loss on a sale against the capital gain — and, in turn, avoid limitations under the IRS’s US$3000 capital loss rule.
Additional Liability Protection
An additional advantage to incorporating as a trading business lies in limited liability opportunities — should a qualified trader opt to form an LLC in place of a sole proprietorship, partnership or S-corp, assets under the LLC are uniquely protected from personal liabilities. However, income garnered under an LLC is reported identically to other types of incorporations through IRS Schedule C (Form 1040), so unless personal liability concerns are a stark priority, there is little benefit to incorporating as an LLC over any other qualified business entity.
For additional professional trading tips, guides and resources, visit Lightspeed’s Active Trading Blog and register now for Lightspeed’s live tax webinar with CPA Robert A. Green, Tips for Professional Traders Getting Ready to File 2020 Tax Returns. For more information on professional trading with Lightspeed, call us at 1-888-577-3123, request a demo, or open an account today.
Active Trading with Lightspeed
Lightspeed provides professional traders with all the tools required to help them find success in stock trading, and we have been developing and honing our active trader platform to offer an optimal user experience. With the intuitive interface layouts and institutional quality stock and options scanners, we aim to help traders reach their goals, no matter what their strategy is. We also offer our clients some of the lowest trading fees in the industry.
Lightspeed Financial Services Group LLC does not hold itself as a tax expert. Regarding any tax related information contained within this webinar and any other tax related items, please consult with your tax advisor.
Data, information, and material (“content”) are provided for informational and educational purposes only. This content neither is, nor should be construed as an offer, solicitation, or recommendation to buy or sell any securities or contracts. Any investment decisions made by the user through the use of such content are solely based on the users’ independent analyses taking into consideration your financial circumstances, investment objectives, and risk tolerance.
Copyright © 2001-2021, Lightspeed, LLC. All Rights Reserved.