Securities trader status not satisfied.

The Tax Court ruled against a couple's deduction of securities losses as ordinary rather than capital and against expenses as trade- or business-related, saying the taxpayers failed to qualify as securities traders and therefore were subject to the capital loss and itemized deduction treatment of investors.

William Holsinger and Joann Mickler of Sarasota, Fla., claimed trade or business status for their stock trading activity to get ordinary loss treatment and thus immediate deductibility of their losses rather than subject them to the $3,000 annual limitation on net capital losses. They also wanted their expenditures classified as business expenses, which would then make them deductions for determining AGI, not itemized deductions from AGI subject to limits.

After trading through their own accounts for some time, the taxpayers created an LLC with one brokerage account in its name. They had it elect IRC [section] 475(f) mark-to-market accounting, which, for securities trading that reaches the level of a trade or business, allows any gain or loss to be recognized each tax year as if the securities were sold on the last day of the year. At the same time, the taxpayers still used their original brokerage accounts and did not transfer the account registrations or taxpayer identification numbers.

To determine whether the taxpayers were in the trade or business of securities trading, the Tax Court relied on established tests. In particular, the trading activity, measured by the regularity of trades and amount of money involved, must be substantial, and the taxpayer must try to capture swings in trading sessions.

The taxpayers' trading activity was not sufficiently substantial, the court decided, with trades on less than 40% of the trading days in the year after the LLC was established and 45% of the trading days in the following year.

The court also found insufficient efforts to capture swings in the market during trading sessions because the trades generally were not entered and then closed out on the same date.

Based on each of these findings, the court decided that expenditures related to these investment activities were not deductible as business expenses. The taxpayers wanted their trading activity to be interpreted as done in the capacity of agents for the LLC, not of individuals for themselves. However, that distinction had no relevance after the court found they had engaged in investment, not trade or business, activity.

The court remarked that it had previously found trading activity to be substantial where, in one tax year, taxpayers executed more than 1,100 stock trades or the value of securities traded totaled $9 million.

* Holsinger v Commissioner, TC Memo 2008-191

By Kevin A. Diehl, CPA, J.D., assistant professor, Western Illinois University, Moline, Ill.

Top Estate Assets

Closely held stock               $2.5 million
Private equity and hedge funds   $1.9 million
Publicly traded stock            $1.7 million
Real estate other than home      $1.1 million
State and local bonds            $908,000

By average per estate tax return, for returns
including that asset category, 2007

Source: IRS, Statistics of Income, Estate Tax Data
Tables, www.irs.gov/pub/irs-soi/07es01fy.xls.