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A problem for traders trying to maximize their cash flow is the archaic IRS rule that caps your available deduction for a capital loss at $3000 in any given tax year. This maximum deduction is for single taxpayers and couples filing jointly.

If there were a way to negate this rule, you would be able to increase your cash flow which, of course, will give you more money with which to trade. For example, a trader with a $13,000 loss in the 25% tax bracket only able to deduct the $3,000 is leaving $10,000 on the table. This equates to an additional tax liability of $2500, a big hit to your trading cash flow (10,000 x .25).

The IRS rule goes on to state that you can carry forward the portion of your loss that was non-deductible in year one to subsequent years and again deduct $3,000 per year. This is a non-productive method of cash flow management.

Can you work around this rule?

Yes, if you are an active trader and can qualify to trade as a business, then form your business and move your brokerage accounts into the business name. After completing these steps, you can elect the IRS section 475 accounting method (Mark-to-Market), which converts your capital gain (loss) to ordinary gain (loss). There is no cap for deductions of ordinary losses, and the tax rate for short- term capital gains and ordinary gains is exactly the same.

However, Mark-to-Market is not a panacea for all traders. You need to meet with your accountant to ascertain whether it makes sense for you to make this election. You also need to know that there are strict rules about the timing, and how to make this election. It needs to be made no later than April 15th of the first year you want to elect it. Mark-to-Market is also a permanent election. To change back from Mark-to-Market accounting you must get IRS approval; however, your accountant should be able to show you how to get around this portion of the rule, if it makes sense for you to do so.

To discover whether you qualify to trade as a business you can go to the IRS website. Using their search engine find IRS publication 550. Buried on almost the last page of the narrative you will find what the IRS thinks will qualify you to trade as a business.

You must remember that there is nothing in the IRS code explicitly defining the business of trading. Everything that is known comes from a U.S. tax court case where some brave trader has attempted to prove that he/she should qualify as a trader.

You should not venture out on your own to ensure that you qualify, but Google "traders status" or "trader in securities" and educate yourself. You will find that even the experts are all over the board on this subject. If you do not have an accountant that understands active traders, there are a couple of good traders accounting firmsthat can help you

This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.