Skip to main content
Image placeholder title

Welcome to a special edition of Tax Forum dedicated to day traders' questions. Among the questions we'll tackle today: How do I handle margin interest? What about retirement options? And what if my spouse has a



Before we get to your questions, we'll examine the two most popular tax-filing packages to see whether they're suitable for traders.

Next week, we'll return to our regular format, so please keep sending any tax questions -- trader-related or not -- to, and please include your full name.

Can Traders Use TaxCut and TurboTax?

Neither of the two best-selling do-it-yourself tax packages --


(INTU) - Get Free Report

TurboTax and


TaxCut -- are configured to handle the reporting needs of traders who elect to mark to market their trades. That means you can forget about filing electronically. I'll tell you why in a moment.

The programs will work just fine if you elect trader status and do


mark to market your trades. (Check out

part two of our Taxes for Traders series for the details on the mark-to-market election.)

But if you are electing to mark to market your trades and still want to use one of these programs, you should be aware of a key reporting issue: The programs cannot automatically handle the transfer of your capital gains or losses from

Schedule D --

Capital Gains and Losses


Schedule C --

Profit or Loss from Business

. You'll have to take some extra steps. Here's how it works.

As a trader, you will file Schedule D to account for what is reported on Form 1099s from your broker. As we detailed in part two of the series, you must then write in a sum that will zero out your Schedule D balance so you can enter those gains or losses on line 1 of Schedule C.

Sounds fine, right? Well, here's the first problem: Under normal circumstances, the total tax on your return is the smaller of your capital-gains tax or your regular tax. If your capital-gains tax is smaller, that's what the software will tell you to pay. But as a trader who elects mark to market, you should not be paying any capital-gains tax, regardless of the amount.



zeroed out Schedule D, but the tax program doesn't know it, so the capital-gains number still will be carried forward to Form 1040 to help determine your overall tax.

Here's the second problem: If you elect to mark to market, you report all your gains on Schedule C. As a trader, you are not subject to self-employment tax. But these programs will automatically calculate self-employment tax on Schedule C income, says Brenda Hochberg, director of federal tax software development at Kiplinger's TaxCut.

What should you do? Here's an option.

You can create two federal tax returns in these programs -- one for the

Internal Revenue Service

and one for worksheet purposes.

In the worksheet file, download all your trades onto Schedule D so that your gain or loss is calculated.

Now input your gain or loss on line 1 of Schedule C in the worksheet file. Enter everything, including all your expenses, in that "fake" form. The software will calculate your net profit or loss.

Now print out both of those worksheets and include them with your


tax return. Just be sure to write "WORKSHEET" across the top to alert the IRS.

From here, manually enter your total gain or loss from line 32 of the worksheet Schedule C onto line 21 (other income) of your real Form 1040, says Hochberg. This will then subject your income to the ordinary tax rates.

This option makes sense, says Keith Washington, group product manager at TurboTax. But don't even think about filing this mess electronically. It'll never go through to the IRS correctly. Perhaps that will wake the IRS up to the fact that the tax forms really need to be adjusted for those mark-to-market traders out there, says Washington.

What If My Spouse Has a 'Real' Job?

If your spouse works in a regular job, can you still qualify as a trader? -- Adrian Byram



part one of the Taxes for Traders series, I said you're not a trader unless your family's next meal depends on your success. That threw some of you off. What if you are a breadwinner, but not the only one in the household?

The thing to keep in mind is that trading must be your primary business, not a sideline or a hobby. As long as you meet all the requirements described in part one of the series, you can file as a trader, regardless of how much money your spouse makes or what he or she does for a living, says Gail Winawer, tax securities partner at

American Express Tax & Business Services

in New York.

What About Retirement?

What retirement options do traders have? I have an IRA, but would like to expand my retirement account exposure. I understand I need to actually pay myself a salary (and double tax myself) to qualify for a SEP-IRA. -- Dave Clemens


You need earned income to contribute to an IRA. But in most circumstances, a trader generally doesn't have earned income. In addition, a trader who elects to mark to market does not pay self-employment tax. So a trader generally cannot contribute to a retirement plan.

The only way you could contribute is if your spouse had earned income or if you were receiving alimony. Because you already have an IRA, I am assuming one of these situations applies to you.

But you have to set up your trading business as a limited liability company (LLC) or an S-corporation if you want to pay yourself a salary, says Ted Tesser, CPA and trader tax specialist in Boca Raton, Fla. That will give you the earned income you need to contribute to a retirement plan. Then your new business can set up a SEP-IRA, Keogh or other retirement plan. And you could set up a personal IRA.

You will now owe

Social Security



taxes on your salary, but it may be worth it to fund your retirement.

What Do I Do with Margin Interest?

Could you please clarify the deductibility of interest paid on margin borrowings through your broker account? When is the interest expense deductible? Do you need to itemize deductions to take advantage of it? Does it offset other income or can it be used to increase the cost basis of the stock purchased? --Mike Yacyk


To start, you can't add margin interest to the cost basis, says Tesser.

Section 163 of the tax law says margin interest is treated as an investment expense. So if you qualify as a trader, you can report the margin interest as an investment expense on Schedule C.

For an investor though, margin interest is an itemized deduction and generally is limited to the amount of investment income you have.

Form 4952

-- Investment Interest Expense Deduction

will help you determine just how much of that interest will qualify as a deduction in the current year. Any unused interest can be carried forward to later years. (See Section 163(d)(2) of the tax code for more on that.)

If, as an investor, you decide to take the standard deduction in 1998, you cannot take a deduction for that margin interest this year. But a portion of that interest may be carried forward to future years.

What About Guys Like Cramer?

What about a guy like Cramer who manages a hedge fund and trades for his own account on a short-term basis? Can he file a return as a trader? -- Tim Truebenbach


First, let me say that I don't know anything about Cramer's financial situation, so I will speak in general terms.

If you run a hedge fund, it's the


that can elect trader status for tax purposes -- not the partners who run the fund, says Winawer. If the partners day trade in the hedge fund, they may very well make this election. But this will be reported on the partnership's return.

If one of the partners has his own trading account and can prove that he trades on a "frequent, regular and continuous basis," he can personally elect trader status.

Can You Attach Brokerage Statements

Back in April, one of your articles indicated that a trader with a high volume of trades could attach broker statements to Schedule D instead of manually entering each transaction. What is the current opinion on this? -- Mike Kohl


Anything that will help make things clearer for the IRS should be included with your tax return. You're not obligated to use Schedule D's additional form,

Schedule D-1

-- Continuation Sheet for Schedule D

if you believe you can offer the IRS something better.

Assuming your brokerage statements are clear and concise and will help the IRS determine how you calculated your capital gain or loss number, then sure, include them. If you have a hard time figuring out your brokerage statements, then forget it.

Nowadays many brokers are providing an additional statement specifically for the IRS, says Winawer. Translation: They are aware that their statements are confusing.

And if you believe that you've kept better records than everyone else, then attach your own schedules. Just be sure to include all pertinent information for each security, date purchased, date sold, proceeds, cost, etc.

I Switched Midyear

If someone left a normal salaried job in midyear and started day trading for his own account, can he file as a trader? Or, in other words, is there a period of time in the tax year that one must exist as a day trader to file as one? -- Deron Goodwin


There is no initiation period you must survive to be considered a trader.

You can start whenever you finally get up the nerve to quit your desk job and trade full time. Remember, the burden of proof is always on the taxpayer, says Alan Salomon, a CPA in Birmingham, Mich. So your documentation is key.

Let's say you decide to embark on a full-time trading career Nov. 1. Make sure you open a separate bank account and trading account on or around that day, says Salomon. That'll help verify that the last two months of the year were spent trading.

TSC Tax Forum aims to provide general tax information. It cannot and does not attempt to provide individual tax advice. All are urged to consult with an accountant as needed about their individual circumstances.