Booyah Breakdown: Taxes for Traders

That has changed, but the IRS still hasn't offered taxpayers any detailed guidance on who is considered a trader. Instead, we have no choice but to look to arcane case law dating back to the 1940s for an answer.

From the case law, experts have fashioned some guidelines. To be considered a trader, you must:

• 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 (although it is possible to be in a partnership which is a trader and run by someone else, according to Ernst & Young). If you have clients or customers, then you're a dealer, and we're not going there today.
• Attempt to make your living off your trading. It's not just something you do at lunch or in your spare time.
• Trade to take advantage of market swings. A trader holds securities for a very short period of time, around 30 days, and focuses on short-term gains rather than dividends and long term gains.
• Trade based on technical, rather than fundamental, factors.

It's important to 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 take a closer look at the requirements.

Weekend Warriors Don't Count

If your trading is a hobby, forget about qualifying. To be considered a trader, your trades must be "frequent, regular and continuous," and you must spend a substantial amount of time doing them. The doctor who does a lot of trades between patients doesn't count. But beyond that, it gets fuzzy. The IRS doesn't define "frequent" or "substantial." So we resort to case law.

In the case of Stephen A. Paoli in 1991, a court rejected the taxpayer's testimony that he spent four hours trading daily throughout the year and found that most transactions occurred in one month. His trading was deemed not to be frequent, regular and continuous, and he was denied trader status. The court also concluded that Paoli didn't depend on income from his trading. He actually received substantial pay from his solely owned corporation.