Trading's Tricky Tax Issues

If you're an active trader, prepare yourself for some thorny tax issues.

Between the constant trades, some option bets and those short sales, your Schedule D -- Capital Gains and Losses could end up being more complicated than those open calls.

The one upside to trading a lot is that you may qualify for the beneficial "trader election," which could save you some tax dollars. But like all good things, there's a catch.

So read on to learn more about some of your bigger tax concerns.

What's Up With the Mark?

"At this point, the biggest issue for active traders is whether you should make the trader election for 2006," says Janice Johnson, the founding chairwoman of the New York State Society of CPA's taxation of financial products committee.

This trader election allows you to mark your trades to market. That means you can recognize the value of your securities as if they were sold for their fair market value on the last business day of the year.

Now don't get nervous -- this is strictly a paper transaction. You don't actually have to sell everything. Just simply subtract your original basis in the stock from the fair market value on that last business day of the year and report the result as your gain or loss. (Check out Section 475 of the tax code if you want more grist).

The best part of this election is that you can declare an unlimited amount of losses. Remember, a regular investor's losses are limited to the amount of his capital gains plus another $3,000. If you make this trader election, the sky's the limit.

So if you have a bad year, this election can be a huge help. But if you win big, expect to pay big, because none of your gains will qualify for the lower long-term 15% capital gains tax rate. Instead, those gains will be taxed at your ordinary tax rate, which could hit 35%.