Editor's note: As a special feature for March,
is offering an ongoing series on everything you need to know about taxes. Today is Part 17.
We seem to have piqued your interest when we tackled filing as a trader in the eyes of the IRS (check out
this previous story for all the grist). We have several follow-up questions, and we'll address some of them today.
We'll also proffer some last-minute tax tips, since your 2006 tax return is due by midnight on April 17. So let's get going!
Some Tricky Trader Queries
If I am using funds in an IRA for all of my trading, can I be considered a trader?
As far as the Internal Revenue Service is concerned, saving for your own retirement is not a business.
If you claim trader status, you're risking the tax-deferred status of your retirement account, because you're saying that it's your business. Granted, there are no court decisions in this area, but this is the current belief at the IRS.
The root of your problem is that your income is not taxed as it is earned in your retirement account. It is taxed as it's taken out. So, sure, the IRS will get its share, but not as a direct result of your trading activity.
As for your trading costs, you can try asking your broker to charge those miscellaneous fees directly to your IRA account so you don't have to withdraw money to pay them. If your broker refuses, you can always write off those expenses as itemized deductions on your tax return.
How do you report a short position on your tax return?
Only when a short position is closed is there a taxable event. So you report short sales only in the year you cover them. If you are holding an open short position at year-end, you won't owe tax on it.
But if you have open positions on Dec. 31, the gross proceeds reported on your
Form 1099-B -- Proceeds from Broker and Barter Exchange Transactions
-- will be greater than the amount you report on your tax return.
You'll need to attach a reconciliation schedule. It can be a plain sheet of paper with your name and Social Security number on it. Write "see attached schedule" in column (a) of your
Schedule D - Capital Gains and Losses
, then attach a form that should look something like this:
- Gross proceeds from Broker ....xxxx
- Less short sales to be reported next year ....yyyy
- Total reported on Schedule D ....zzzz
The final number should be the total sales in column (d) on Schedule D.
Big note: If you're a trader in the eyes of the IRS and you elect to mark your trades to market (see
this story for those gory details), your shorts would all be recognized at the end of the year, regardless of their position.
I have a question about broad-based index options that receive 60/40 treatment: Do profits from short sales get 60/40, or do they come under the "all short-sale profits are short-term capital gains" rule?
When you short a broad-based index, your gains and losses on the short position will be subject to the so-called 60/40 rule.
The 60/40 rule applies to any regulated futures contract, foreign currency contract or nonequity option (options on stock index futures or broad-based stock indices, such as the
index), according to Section 1256 of the tax code.
The rule says that 60% of the gain or loss is long term and 40% is short term, regardless of the actual time it's held.
In this case, the short follows the rules of the underlying long position. So the 60/40 rule would apply here as well.
Last-Minute Tax Reminders
Whether you file your 2006 tax return or an extension, it doesn't really matter. You just need to do something -- unless you don't owe taxes. But if you do, and Uncle Sam doesn't receive some correspondence from you by midnight April 17, then you'll get smacked with a late filing penalty that rakes in 5% per month based on the amount of tax you didn't pay on time. And that can add up fast.
And it's OK to throw in the towel and extend (I certainly won't think less of you). You'll just need to file
Form 4868 -- Application for Automatic Extension of Time to File U.S. Individual Tax Return
The good news is that you'll buy yourself an automatic six months. So you're return will then be due Oct. 16.
The bad news is that you probably still have to complete your tax return to properly fill out Form 4868.
That's because Form 4868 asks for two numbers from your federal return, Form 1040. The first number is your total tax liability, which is line 63, and the second number is your total payments, which is line 71. So you'll need fill in all the other lines on the form to calculate those two.
The easiest way to file your extension is to do it through your tax preparation program of choice.
Or you can go to
irs.gov and download the form. Print it out, fill it out and mail it in. Just be sure to send it certified mail so you get confirmation that the IRS received it.
If you have a tax balance due, and you don't want to mail a check in, you can authorize an electronic funds withdrawal from your checking or savings account right over the phone. If you choose to do this, make sure you have your adjusted gross income from last year's tax return for verification.
Still Need the Money, Honey
If you don't pay your bill by April 17, a 0.5% per month penalty will be imposed for paying late.
But if you don't have the cash to pay your tax bill, don't panic. Send your return or extension in anyway and pay as much as you can. Remember, there's a 5%-per-month penalty for filing your return late, but only a 0.5%-per-month penalty for not paying the bill on time.
Then consider your options:
The IRS will let you charge your tax bill through
Link2Gov Corp., using your American Express, MasterCard, Visa or Discover Card. The companies charge a small processing fee (no IRS fee though), but at least you'll rack up your airline miles. Just make sure the miles outweigh the fees and corresponding interest your credit card will charge if you don't pay your bill on time.
If you don't want to charge your bill, the IRS will let you go on a payment plan. Uncle Sam will pretty much let you decide on your monthly payment amount, so think it through because once you pick a number, it must be maintained over the life of the agreement.
Form 9465 -- Installment Agreement Request
or create your own written request. Be sure to specify the amount you can pay and the day you wish to make your payment each month. Whichever you choose, attach it to the front of your tax return.
- Sign your return.
- If you are writing a check, make it out to the United States Treasury, not the IRS. Scammers in the past have intercepted tax checks and changed the "I" to an "M." then the check could be made out to "MRS. Anyone" and she gets the money instead of Uncle Sam.
- Make your traditional IRA or Roth contribution -- or open a new IRA account -- before midnight April 17.
So to all the procrastinators out there, good luck getting your return or extension down this weekend. I'll be struggling right along with you.
Tracy Byrnes is an award-winning writer specializing in tax and accounting issues. As a freelancer, she has written columns for wsj.com and the New York Post and her work has appeared in SmartMoney and on CBS MarketWatch. Prior to freelancing, she spent four years as a senior writer for TheStreet.com. Before that, she was an accountant with Ernst & Young. She has a B.A. in English and economics from Lehigh University and an M.B.A. in accounting from Rutgers University. Byrnes appreciates your feedback;
to send her an email.