How Do I Explain My Mark-to-Market Moves to the IRS?

Also, deducting margin interest and establishing Roth IRAs for nonworking spouses.
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I plan to mark to market my trades when I file my taxes. Since my securities will be treated as if they were sold on the last day of the year, the figures I turn in to the Internal Revenue Service will not match up with the 1099-B that I receive from my broker -- either this year or next. How does the IRS look at this? -- James McDonald


If you were a trader in 1998 and you elected to mark to market your trades at year-end, you recognized the value of your securities as if they were sold for their fair market value on the last business day of the year. (See our Taxes for Traders

series for more on trader status.) Odds are good that the amount listed as gross proceeds on your

Form 1099B

- Proceeds from Broker and Barter Exchange Transaction

will not match the amount you're going to report on your

Schedule D

- Capital Gains and Losses


You therefore should create a separate statement that explains the difference between these numbers, recommends Ted Tesser, a certified public accountant in Boca Raton, Fla., and author of

The Trader's Tax Survival Guide

. Be specific and show the IRS how you derived your capital gains number and explain the exact reason for the difference. Be sure to keep all supporting documents in your files just in case the IRS comes looking for you.

Title the explanation "Statement 1" and attach it to the back of your tax return. Then write "See Statement 1 Attached" on Schedule D to alert the IRS to your reconciliation. Check out Mike Bauer's

tax return for an example of an attached statement.

Remember that traders who mark to market their trades may not be the only ones who will have reconciliation problems. If you reported any option sales or had open short sales still at year-end, your 1099Bs would not match the amount you report either. Again, just prepare and attach a reconciliation statement. Check out this

Tax Forum for more on reporting open shorts at year-end.

Don't make the mistake of assuming the IRS will understand why your numbers don't jibe. As Tesser reminds us, when it comes to the IRS, assume nothing and be prepared for anything.

Itemizing Margin Interest

I had margin interest last year. According to everything I have read, the only way I can deduct it is if I itemize. Is this a correct assumption or is there some other solution to offset my capital gains with margin interest? I don't itemize so I need a solution. -- Kevin Shendok


If you do not itemize your deductions on

Schedule A

- Itemized Deductions

, you cannot deduct your margin interest, says Martin Nissenbaum, national director of personal income tax planning at

Ernst & Young

. But you are essentially getting the margin interest deduction through your standard deduction, assuming it's higher than your itemized deductions, notes Nissenbaum.

Remember, you can't add your margin interest expense to the cost basis because it's an investment expense, according to

Section 163 of the tax code.

Although margin interest generally is limited to the amount of investment income you have, you can carry a portion of that interest forward to future years, notes Nissenbaum. So if you itemize in future years, you may be able to deduct the interest at that time.

Form 4952

- Investment Interest Expense Deduction

will help you determine just how much of that interest qualifies as a deduction in the current year and how much you can carry forward indefinitely to later years.

But don't forget: If you qualify as a trader, you can report the margin interest as an investment expense on Schedule C. See this previous

Tax Forum for more on a trader's deductions.

Nonworking Spouse Wants a Roth

In the following situation, can Roth IRAs be established for 1998 and 1999? Husband and wife (both under 55) file jointly; husband is a self-employed attorney; wife receives permanent Social Security disability and private insurance disability payments which also include monthly contributions to a retirement annuity. Adjusted gross income is less than $150,000 including a portion of Social Security disability. Private insurance payments are not taxable. Can each have a Roth IRA, or husband only? -- Sally Hale


To open a Roth IRA you must have compensation. That includes wages, salaries, fees and self-employed income. (See

Section 32(c)(2) of the tax code for more.) Social Security disability payments would not count as such, so the wife can't open a Roth IRA on her own.

But since the husband does have compensation, the tax law would consider the wife a nonworking spouse. A nonworking spouse can contribute up to $2,000 to a Roth IRA as long as the working spouse's adjusted gross income is at least $4,000, according to

Section 219 of the tax code. So both husband and wife can make contributions of up to $2,000 to each of their own accounts. Note that since 1997, the same rule applies to the traditional IRA as well.

Then as long as the adjusted gross income stays below $160,000 (if the two file a joint return), the wife can continue to contribute to the Roth in the future years. (A single person's AGI must stay below $110,000.)

Check out

Publication 590

- Individual Retirement Arrangements

for more on the Roth and traditional IRA rules.

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