Trading's Tricky Tax Issues

One more downside: Once you make the election, you're stuck with it. You can't flip-flop each year. You'll need to petition your decision with the IRS. And remember, you're making this election for the 2006 tax year. If you didn't make this election last year, with your 2004 tax return, then you can't mark your trades to market on your 2005 return.

But let's first determine if you qualify this treatment.

To Trade or Not to Trade

You may be a trader, for tax purposes, if:

• You trade for your own personal account. And you must do the trading yourself. You can't hire someone to do it for you, nor can you trade for someone else. If you have clients or customers, then you're a dealer, and we're not going there today.
• You make your living off your trading. It's not just something you do at lunch or in your spare time.
• You trade to take advantage of market swings. A trader holds securities for a very short period of time, around 30 days.
• You trade based on technical, rather than fundamental, factors.

Note that if only one or two of these criteria apply to you, you are not a trader. All must apply, and even then, it's not a sure thing. The devil is in the details, so be really sure about your decision or you'll have Uncle Sam breathing down your back.

If you think you qualify, then you need to inform the IRS by April 15 that you want to make the election for the 2006 trading year. There's no official form, so create a written statement and attach it to your 2005 tax return or extension.

And one more important point: Be very specific about which accounts you want to mark to market, says Johnson. Leave your long-term investment accounts or any commodities trades outside this election.

Why? To start, you want your long-term accounts to get the beneficial 15% long-term capital gains rate. And on the futures/commodities front, you want their beneficial treatment as well. Typically, futures, commodities and nonequity options are subject to the great 60/40 rule. The 60/40 rule says those gains are automatically considered 60% long term and 40% short term on Schedule D, regardless of the time the security is held. So don't lose that perk to the mark to market election. Keep those trades in a separate account.

Shorty Shorts

If you dabble in short positions, pay attention.

Only when a short position is closed is there a taxable event. So you report short sales only in the year you cover them. If you are holding an open short position at year-end, you won't owe tax on it.