Paying the piper: some tax rules for day traders.
The Taxpayer Relief Act of 1997 contained several provisions that both help and hurt day traders in their computation of income taxes. First, the act permits the day trader to use mark to market accounting for his or her security portfolio. This allows him or her to recognize gains or losses in the value of a security portfolio before a gain is realized by the sale of a security. Since day trading is characterized by rapid turnover of securities and the day trader does not want to hold securities overnight, the effects of this provision are hard to determine.
Second, a day trader can classify his or her activities as a business to be reported under schedule C of form 1040. This is significantly better for the trader than the provisions that applied before the act went into effect. Previously, a day trader was limited to annual capital losses of $3,000, regardless of whether he or she had short- or long-term losses. But if he or she files as a business, there is no limitation to the total losses that can be taken. Since many day traders have experienced large losses, this is a significant tax benefit.
Third, the trader has greater latitude in deducting costs. As an individual, the day trader would have to deduct business costs on schedule A of form 1040 where 2% of adjusted gross income is first subtracted from the deduction. But if that trader classifies his or her activities as a business, such expenses--which include computer equipment, software, communication expenses, margin interest and related items--are fully deductible, and the 2% rule does not apply.
However, there are several negative tax rules associated with day trading. First, any gains are subject to both income and self-employment taxes. The trader would have to pay employment taxes as a self-employed individual for the net business gains over the tax period.
In addition, the act placed certain accounting burdens on the day trader. He or she must segregate investments into trading securities and investment securities. This means that the gains and losses from the investment securities are recorded on schedule D and the trading gains and losses are recorded on schedule C. There is no specific regulation to use as a guide in differentiating the securities into trading and investment portfolios.
Finally, the IRS has issued no formal guidelines as to who qualifies as a day trader. Some factors that might be relevant would include (1) the number of trades an individual makes, (2) the intent of the individual, (3) how long an individual holds securities and the amount of time devoted to trading activities, (4) sources of income other than day trading and (5) the nature of the investment account and the relationship the individual maintains with the investment bank.
Uncle Sam's Budget for 2001
Government figures for the next fiscal year show discretionary spending--such as that for education, agriculture and defense--amounting to approximately 30 cents of every federal tax dollar. Mandatory spending and net interest will account for nearly 70 cents of each dollar.
Social Security 23 [cts.] Health and medical 21 [cts.] Income security 14 [cts.] Net interest 11 [cts.]
National defense 16 [cts.] Education training 4 [cts.] Transportation 3 [cts.] Veterans 3 [cts.] Other 5 [cts.]
--Marc I. Lebow, CPA, PhD, associate professor of accounting at Christopher Newport University in Newport News, Virginia, and P. Michael McLain, CPA, DBA, assistant professor of accounting at Hampton University Hampton, Virginia.
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|Author:||McLain, Michael P.|
|Publication:||Journal of Accountancy|
|Date:||Oct 1, 2000|
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