I just read your article, How to File a Return That Tells the IRS You're a Trader, and I have a few questions.
Can I file as a trader without electing to mark to market my trades? Will I lose long-term capital gains treatment? Can I still transfer my gains and losses from Schedule D to Schedule C? (Note, I am not concerned about deducting unlimited capital losses.) If I mark to market, do I loose any Schedule C deductions? Do I have to pay self-employment tax? Also, I filled out my return using the Section 475 election wording on my Schedule C and D, but I am not marking to market. Looks like that was incorrect to me now. -- Kevin Madok
Whoa. I think you're confusing some things. Let's walk through this slowly.
First, be sure you meet the
stringent requirements to file as a trader for tax purposes. If you are unsure whether you qualify, Ted Tesser, trader tax specialist and author of
The Trader's Tax Solution
, has created a trader evaluation questionnaire. He is offering it free to
readers who email him at
Traders who meet the requirements have the
of reporting their trades on
-- Capital Gains and Losses --
like everyone else, or electing to mark-to-market their trades on
-- Profit or Loss from Business --
By the way, section 475 and the mark-to-market election are the same thing.
Section 475 is the part of the tax code that allows traders to make the mark-to-market election.
By marking your trades to market, you are recognizing the value of your securities as if they were sold at fair market value on the last business day of the year. It's just a paper transaction, but any of those gains and losses will be taxed at your ordinary income tax rates. So you do lose the preferential 20% long-term capital gains rate with this election. The good news is that you're allowed unlimited losses with this election.
But you can't just wake up one morning and decide that you're going to mark-to-market your trades. You need to make this decision in advance. As a matter of fact, the
Internal Revenue Service
requires that traders make this election by April 15 (or the first business day thereafter) on the previous year's tax return.
So if you want to mark your trades to market in 2000, you should have made that declaration on your 1999 tax return that was due in April. If you didn't, it's too late for this tax year. If you want to make this election in 2001, make sure you declare that intention with your 2000 tax return (or extension application) that's due on April 15, 2001. For more on the details of this election, check out this previous
If you decide you don't want to mark to market your trades, you'll have to report your gains and losses on Schedule D, just like the rest of us. Your losses would be limited to the amount of your capital gains, plus an additional $3,000 a year. You would then get the benefit of the 20% long-term capital gains rate. In this case, there would be no need to transfer your gains or losses to Schedule C.
But just because you don't mark-to-market doesn't mean you lose the other perks of filing as a trader.
Here's the biggest bonus: Because you have a "trading business," you can deduct 100% of your associated expenses on Schedule C. Regular investors must report their investment expenses on
-- Itemized Deductions
. Those expenses then are deductible only if they exceed 2% of adjusted gross income.
Better still, as a trader, you can deduct more than the usual
investing-related deductions, such as subscription fees, investment books and tapes, and accounting, legal and tax advice.
For instance, traders can and should take a
home office deduction to further support the notion that they sit at home and trade for a living. Investors can't take a home office deduction because of their investments. Reread
How to File a Return That Tells the IRS You're a Trader for more information on this.
And as a trader, regardless of what you report on Schedule C, you will not be subject to self-employment tax. Just another perk to filing as a trader.
I'm sorry to say that it appears that you may have prepared your tax return incorrectly. You may want to talk to a professional about preparing an amended tax return,
-- Amended U.S. Individual Income Tax Return
. If it turns out you owe more taxes after amending your return, doing it sooner rather than later would limit any penalties or interest the IRS would charge you for your errors.
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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.
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