Tracy Byrnes and Ted Tesser Chat on Yahoo!, Mar. 22

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TSC's Tracy Byrnes and Ted Tesser chatted on Yahoo! on Wednesday, Mar. 22. As with all chats, this transcript is unedited.

TSCtracy:

Hi All! Welcome to tax season! Thankfully we have our trader-tax guru with us to address those sticky trader tax questions you have!

TSCtracy:

So welcome Ted Tesser to our chat. So shoot him your best, toughest questions!

suezey asks:

Filing a Schedule D, can you deduct a home office?

tax_trader_tsc:

Yes if you qualify for trader status and have a profit you can deduct home office.

TSCtracy:

Check out the piece we did on the home office deduciton on TSC!

ybn1 asks:

Assuming I qualify as a trader, do I have the choice not to elect the market-to-market and use Sch. D for the capital gain and losses with the 1256 and the $3,000 loss limit? Since I am in high AGI bracket, I have high stock market profits and I use OEX options I don't mind having to use the Sch. D but I like to be able to take my investment expenses on Sch. C. Thanks.. Ybn1

tax_trader_tsc:

You do not have to elect mark to market and if you qualify as a trader, you can deduct your TRADING expenses on Sch C and keep the 1256 income on Sch D.

falcocolumbarious asks:

Can you give some general strategies for avoiding big capital gains taxes?

TSCtracy:

Good question!

tax_trader_tsc:

You can lose money as most traders initially do but seriously, the best way is to form a series of entities and set up programs to shelter your income such as retirement plans, VEBAs, and 419 trusts.

TSCtracy:

Can the elaborate on the specific entities?

tax_trader_tsc:

As a trader. An individual is limited in the programs that can be set up. As an entity, such as an S corp, or Family Limited Partnership or LLC you can fund various retirement programs and other employee benefit programs.

TSCtracy:

Can you trade in an FLP? I thought the govt was cracking down on these.

tax_trader_tsc:

Yes you can.

TSCtracy:

Really?!

tax_trader_tsc:

The govt is cracking down on FLP's that have no business basis As a trader, in the business of trading, you have a valid business reason FLPs are meant to do valid business.

TSCtracy:

Do you set clients up in FLPs then?

tax_trader_tsc:

Yes. Part of the services we provide is to structure clients in the proper entities or series of entities, such as a Corp as general Partner of a FLP.

TSCtracy:

Wow I learned something already!

TSCtracy:

With an online broker: can you elect specific lot ID for the stock you sell?

tax_trader_tsc:

You have 3 choices for electing the basis of stock you sell. The first if nothing is stated by you will be first in first out. The second choice you have when you sell a particular stock is average cost of all the shares you own and the third choice is specific identification of lots that you wish to sell.

tax_trader_tsc:

The best way to substantiate the specific identification is to follow up your sale with a certified letter to the broker restating the specific lots you sold. Put this in your tax file for future proof.

TSCtracy:

But what if the broker does not have the tech capablities of selecting a particular lot?

tax_trader_tsc:

My feeling would be that as long as you indicate in a certified letter which lot you sold, it will hold up. There is really no difference in the shares that are sold as long as you identify them.

TSCtracy:

So keep really good records!

suezey asks:

Can margin interest be deducted on Schedule a?

tax_trader_tsc:

The answer is it can be deducted as an investment expense only up to the amount in any particular year of investment income and investment income is generally limited to interest and dividends, unless you elect to include capital gains.

tax_trader_tsc:

If you do include capital gains, you forgo long term capital gain treatment.

TSCtracy:

Check out the piece we did on TSC on margin interest.

TSCtracy:

www.thestreet.com/funds/taxforum/900131.html

TSCtracy:

Ted, where do traders report margin interest?

tax_trader_tsc:

As a trader, you are entitled to a 100% deduction of TRADING interest on a Sch C regardless of whether or not there has been income.

TSCtracy:

So the limitation only applies to investors

tax_trader_tsc:

Correct.

TSCtracy:

Here's one: Under what conditions is it best to elect 475 if you have a loss?

tax_trader_tsc:

If you have a loss it is advantageous to elect 475 in the year you have the loss. By doing so, you can deduct an unlimited loss as opposed to the $3,000 capital loss limitation.

tax_trader_tsc:

The problem is with RevProc 9917, in March of 1999, the IRS put many restrictions on when you must elect 475. So, it is often not possible to elect 475 after the fact, except under certain circumstances.

TSCtracy:

Circumstances? Like?

tax_trader_tsc:

After 1998 tax returns were filed, for years 1999 and subsequent to that the election must be made by the extension date of the prior year's tax return or the filing of that tax return whichever comes first.

TSCtracy:

Check out this TSC story for more details:

TSCtracy:

www.thestreet.com/funds/taxes/880943.html

tax_trader_tsc:

The extenuating circumstances in which you are allowed to elect 475 after the fact is for a new entity.

jimfink asks:

Does the Section 1256 60% long-term capital gains treatment apply to all S&P 100 option trades or only open positions that are carried over into the new tax year?

tax_trader_tsc:

Which never filed a prior year tax return.

TSCtracy:

But if started 1999, did I miss the election, hang on jimfink! we'll get to you next!

tax_trader_tsc:

If you started trading in 1999, on your individual return, you missed the election. However, if you started trading from a new entity in 1999, then you still have the opportunity to elect with your tax return. Although, technically you should have put it in the minutes of the entity's Board of Directors meeting within 2 and one half months of formation.

CleopatraAnthoney asks:

For a person holding a L/T GAIN on a stock., what are the ramifications of sell a DEEP IN THE MONEY call as a hedge??

tax_trader_tsc:

Where there is the sale of essentially the same stock or trading vehicle, you have wash sale transaction considerations as well as potential of a riskless transaction which would include possibly shorting against the box, which would consider the transaction essentially closed for tax purposes and the gain, if there is a gain taken.

tekmp asks:

So, do I have to send in a form 3115 before I file this years return to get 475 status?

tax_trader_tsc:

If you did not already elect 475, for your 1999 individual income tax return, it does not matter if you send in form 3115 or not, you have missed the opportunity for 1999 to mark to market.

tax_trader_tsc:

However, if it is a new entity for which a tax return has never been filed, you then can elect 475 with the filing of the tax return and there would be no need for a 3115, as there was not a previous accounting method.

tax_trader_tsc:

The election would be made supposedly 2 and a half months after formation in the Bd o D meeting and indicated with specific language on the initial tax return.

TSCtracy:

Who's Bd of Dir?

tax_trader_tsc:

We are talking about the BOD of the new entity

TSCtracy:

So that could be just me?

tax_trader_tsc:

No, it cannot be an individual unless you were born in 1999 and I wouldn't suppose you would have too much trading activity if you were. However if you formed a FLP or Corp in 1999, and started trading from it, you could still technically elect 475.

SAILOR64SD asks:

Have you written books that cover the tax aspects of being a trader? If so what is your URL?

tax_trader_tsc:

I have a new book, The Traders Tax Solution.

TSCtracy:

You must be related to Ted.

tax_trader_tsc:

Which has been released in the last month This book covers most of the technical aspects of all of these issues.

TSCtracy:

It's the follow-up to the Traders Tax Survival Guide -- for all you fans out there.

tax_trader_tsc:

Yes it is.

TSCtracy:

Go to amazon.

HeartsmyGame asks:

I have a consulting business but am a heavy trader - Can I designate myself as a trader if I also am a sole proprietor of other entities?

tax_trader_tsc:

IF you are a Trader and qualify as such, you can consider your trading to be a business. It can be filed as a Sch C or through an entity.

tax_trader_tsc:

It is not necessarily a dependent on whether or not you have another consulting business. I will say though that it is somewhat easier although not a requirement, if you trade full time.

TSCtracy:

So moral of the story :

TSCtracy:

You can have another job and still qualify as a trader. Right, Ted?

tax_trader_tsc:

There is nothing in the Code or that has come out of tax court that precludes having another job. You must trade on a frequent, regular and substantial basis and have a history of continuous short term trades. That is the crux of what it takes to be a trader although there are many other considerations as well.

sirwanksalot2 asks:

If you keep a stock for over 7 years, how does the IRA know what you paid for it? Do people cheat on their capital gains? I know I don't.

tax_trader_tsc:

That is actually a good questions and one which I am asked quite often. If you are audited, it is possible for the auditor to request records of the purchase of your securities. But to be quite honest, I have rarely seen it done.

TSCtracy:

You've rarely trader audits?

TSCtracy:

:)

tax_trader_tsc:

NO, what I am saying is that in an audit, I have only experienced the auditor requesting purchase confirmations on capital gain transactions several times in my 25 year career. So it is possible, but does not happen too often. But this is not a license for any one to make up cost basis.

TSCtracy:

But have you seen traders get audited?

tax_trader_tsc:

I have been through some audits on Trader Status tax returns. I do not see it being a red flag and in my experience, I have never lost a case where I have filed somebody as a Trader and gone to audit over it. The only exceptions have been when the cost of going through an audit has exceeded the potential gain of defending trader status.

TSCtracy:

That's a good point for any audit -- make sure its economically worth it.

tax_trader_tsc:

I had an interesting case last year where I amended several back years of a Traders tax return who had¿

TSCtracy:

oh boy¿

tax_trader_tsc:

originally filed as an investor. We requested a refund of over $150,000.00 and naturally the IRS wanted to take a look at those returns

TSCtracy:

Naturally.

tax_trader_tsc:

I write about the specifics of this case in my new book, but I will tell you that it was disallowed in the front line audit. However, upheld 100% in appeals.

TSCtracy:

Really?

tax_trader_tsc:

And we received a refund of $150,000.00 plus interest plus more money from NY State. So, I will tell you that if you have a solid case do not let the spectre of an audit scare you away. It can be worth mucho money if you qualify.

brent52299 asks:

Ted I trade for Bright trading and was wondering if I qualify for trader status. I gave them a $25,000 deposit and that allows me to trade their capital during the day. What do you think?

tax_trader_tsc:

I have no idea based on that information I have developed a 40 questions Trader Questionnaire which I will gladly make available to anyone who emails me at tbtesser@aol.com.

TSCtracy:

But in general if you trade someone else's money, you don't qualify for trader status. Right?

tax_trader_tsc:

That is not necessarily true.

TSCtracy:

oh boy

tax_trader_tsc:

And in particular if you put up your own money and trade on margin, that is even more of a case for trader status.

TSCtracy:

Sure that makes sense.

tax_trader_tsc:

As the extent of leverage is a consideration.

TSCtracy:

got it.

tekmp asks:

O>K, So I missed out on 475 for 1999, how can I make sure to get it for 2000? I am an individual and don't want be a corp. unless I start making some big gains.

tax_trader_tsc:

You can elect 475 for the year 2000 by indicating that you are doing so on your 1999 extension or the filing of your 1999 tax return, whichever comes first.

randypotter asks:

Can a person qualify as a trader if they have 10 short term trades a month but also has a large portfolio of mutual funds which are not traded?

tax_trader_tsc:

It is possible but it depends on many other circumstances.

TSCtracy:

Like his frequency?

tax_trader_tsc:

His trading frequency is ok but not great.

TSCtracy:

Get out there and trade, Randy!

tax_trader_tsc:

The other factors I would look at are whether or not this is being done on a full time basis and if the trading income is supporting his lifestyle. If the answer to those questions is YES YES, then it would be more lenient on the number of trades or trading frequency, but there are many other factors that I would evaluate as well.

smsinger_1 asks:

Is there any way to contribute to some type of retirement plan filing as a trader and using a schedule C?

tax_trader_tsc:

No there is not unless you trade from the floor of an exchange in that case, the income would become self-employment income and be qualified for making a SEP or Keogh contribution.

TSCtracy:

That means you have a seat on one of the exchanges HeartsmyGame asks: My situation is rather unusual in that I had a tricky divorce (with puts and calls) and as a result had a $800K capital loss carry forward which will be dissipated this year (I hope). My CPA is not up to speed on trading ramifications and my situation is not sufficiently common to warrant being answered on thestreet.com. Are there "experts" that I can pay to give me opinions?

TSCtracy:

Just email Tted for more info!

mchow asks:

I've heard that if I claim a home office tax deduction and then sell my home, the percentage that I claimed as a home office deduction would be taxed on the sale's profits? Is this true?

tax_trader_tsc:

Yes, that is one of the disadvantages of claiming home office. You cannot get the deduction without considering the recapture on the sale.

TSCtracy:

Check out this TSC story:

TSCtracy:

www.thestreet.com/funds/taxforum/897003.html

TSCtracy:

for more on that recap depre¿

falcocolumbarious asks:

I have an idle S Corp. Could I start trading through it?

tax_trader_tsc:

If it is still a valid entity, meaning if all the compliance issues have been met while it has been in existence-i.e. tax returns filed bod meetings, and minutes kept, then you can begin doing business in the SubS.

Icover asks:

Ted, are there a number of trades a year that is required to be considered a "trader?"

tax_trader_tsc:

There is no quantitative amount that has ever been determined by either the tax code or tax court.

TSCtracy:

That's what makes all this so fun.

tax_trader_tsc:

I can tell you, however, how little is too little. In 1995 there was a tax court case called Steffler vs the Commissioner in which this tax payer claimed Trader Status. He traded commodities full time.

TSCtracy:

I remember this case....

tax_trader_tsc:

But was ruled not to be a Trader. The problem was he only had 18 trades over the course of 3 Years. So there is no minimum amount but to be a Trader you must generate "substantial" trading activity.

crbrauer asks:

I just realized a 90K short term gain on a stock sale. When must I pay the ST gain tax? Now or next tax season?

tax_trader_tsc:

If you are generating income throughout the year you should cover the tax liability for that income on a quarterly basis with estimates. There are exceptions to this rule where you will not be penalized if you do not cover the liability.

tax_trader_tsc:

Those exceptions are: if you pay in 90% of the current year's tax liability, or if you have less than $1,000 due with the return, or there is an exception based on last year's liability. You must cover 100% of last year's liability up to a certain income level and then 110% after you have a certain level of income.

mchow asks:

I am planning to start a small home business doing computer consulting. I want to deduct the cost of the hardware and software, but am afraid my business may be classified as a hobby and not be tax deductible. How can I have the small business avoid being classified as a hobby?

tax_trader_tsc:

You can make money doing it!

TSCtracy:

But what if I have losses?

tax_trader_tsc:

The IRS has run on the presumption that a business should be profitable by the third year of operation If it is not, they can reclassify it as a hobby but there is nothing etched in stone. I have defended businesses that have not been profitable after many years. It is just a presumption on their part. If you show you are truly running a business and trying to make money, then profitability is not an essential part of the equation.

TSCtracy:

If the IRS reclassifies as a hobby, you'd have to go back an amend, right? And then your losses are limited to your total income. That means you'll owe big bucks.

tax_trader_tsc:

If the IRS makes a determination in the front line audit that you are a hobby, you still have the option of many levels in which to appeal this decision. However, if the final determination is that you have a hobby then you must amend prior years tax returns within statute and you cannot deduct more expense than income in any year as a hobby.

falcocolumbarious asks:

Can the WSJ, cable, books, and subscription investment info services be taken as deductions?

tax_trader_tsc:

If these expenses are either investment expenses or trading expenses.

TSCtracy:

Read this: www.thestreet.com/funds/taxforum/898497.html

tax_trader_tsc:

Then they can be deducted in the appropriate manner as either a Sch C or Sch A deduction.

TSCtracy:

Is the jury out on selling in your taxable account and buying the stock back in an IRA? wash sale?

tax_trader_tsc:

You can sell any stock and buy it back in an IRA. If you had a loss, on the first sale you would think the wash sale would be present. However, I have taken the position that repurchasing the stock in an IRA is a purchase by a new entity.

TSCtracy:

And so far, no resistance from the IRS on that?

tax_trader_tsc:

I have never had a problem. However, there are unclear definitions in the code of what a riskless transaction is and although I have never seen a reference to this type of activity, it is possible that the IRS might consider it to be one.

TSCtracy:

So buyer beware.

dgarcia801 asks:

Tracy, you're beautiful. When will you be on the show again?

TSCtracy:

I'm not sure -- but stay tuned. Thanks though.

TSCtracy:

Whew!

TSCtracy:

Ted, thanks so much for taking time out of your hectic schedule to help us tackle these issues!

tax_trader_tsc:

Thanks for having me Tracy.

TSCtracy:

Please come back soon!

tax_trader_tsc:

I look forward to our next chatroom.

TSCtracy:

As long as the tax code stays vague, the chats will keep comin'!

laura_the_street:

Thanks for joining us this eve.