Taxes for Traders

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The tax season is especially tough for traders because the Internal Revenue Service has implemented confusing rules regarding trader status, profit recognition and position reporting. This makes tax filing through manual calculation or popular software, such as TurboTax, almost impossible for traders to accomplish.

Fortunately, a variety of tax services has sprung up to address the unique needs of active traders. These services are surprisingly affordable, given the advanced knowledge required to accurately complete tax filings. And these companies do a better job keeping profits in traders' pockets than mainstream firms geared toward investors.

I'm no expert on trader taxes, although I receive dozens of questions on the subject each year. Fortunately I ran into Jim Crimmins, a Phoenix resident and president of Traders Accounting, a provider of tax services to the trading industry.

I spent time picking his brain last week and want to share that fascinating discussion with you today.

Let's start with the issue of trader tax status. How does the IRS distinguish a trader from an investor?

Well, the tongue-in-cheek answer would be -- not very well. Trader tax status is perhaps the biggest ongoing tax issue facing traders today, for the simple reason the IRS has failed to unequivocally draw the line between trading and investing. Instead, we're left to interpret what the IRS means by such tests as "substantial, regular and continuous" trading activity.

Can you be a part-time trader and hold another job? Unclear. Are 200 trades a year sufficient for trader status? Again, it's unclear. To make matters worse, the guidelines for trader status, such as they are, continue to evolve as the result of tax court rulings. When these appellate judges overstep their bounds, it adds another layer of uncertainty to an already murky situation.