Do you Qualify as a Trader for Tax Purposes?

In today's internet age, anyone has the ability to buy and sell stocks at the push of a button. While some individuals dabble in the market, others spend a significant portion of their day buying, selling and researching.  Whether you qualify as a trader depends on factors the IRS looks at to categorize taxpayers as either “investors” or “traders.”  Traders can qualify for better tax treatment so it is important to determine what classification applies to you.

Most taxpayers fall under the “investor” definition.  If you buy and sell stocks for long-term growth and dividends, you are an investor[1].  As an investor, you typically report income on your tax return each year when you receive “dividends.”  Dividends are reported to stockholders by the company that generates the income on a 1099-DIV.  Then, when you sell your stock, the company reports the sale of the stock and the basis (the value of the stock when it was purchased, plus costs) of the stock on a 1099-B. 

When the sale of stock is reported on your tax return, you will either have a gain or a loss.  The gain or loss created upon the sale is called a “capital” gain or loss, and it is combined with other capital gains or losses that you have from other capital transactions during the same tax year.  If there is not enough capital gain to offset your losses, the IRS allows you to deduct up to $3,000 of that loss against your ordinary income.  If you have a capital loss greater than $3,000, you may carry forward the excess loss to the next tax year.

What does it take to be qualified as a “trader,” and why does it matter?

If you qualify as a trader, you are considered to be operating a business.  As such, you can take business deductions (ordinary losses) against your trading income (most typically on a Schedule C if you are 1040 filer).  Another added benefit to be aware of is that if you are trading for yourself, you are not subject to self-employment taxes as are most other business owners. 

But it is not so simple to qualify as a trader.  You must meet all the following criteria:

1. Your trading income or losses must come from short-term market movements and not from long term holdings;
2. Your trading must be substantial;
3. You must trade on a regular and continuous basis.

Taxpayers who trade from time to time (even if they hold stock for short term periods) will probably not meet these tests.  Some taxpayers who consider themselves “day traders” may or may not meet the above tests. 

In an audit, the IRS will look at the volume of your trades throughout the year (dollar amount, number of shares, type of trades), how often you traded (daily, weekly, sporadically), what your other sources of income might have been (are you employed or otherwise financially supported), and how much time you spend on your trading (studying charts, researching on-line, reading financial papers/articles, in addition to actual trading).

While the tax benefits of qualifying as a Trader are appealing, the tax laws governing traders are complex.

If you have further questions on this topic, please feel free to call us to discuss them in detail at Glick and Trostin, LLC at 312-346-8258.

Disclaimer: The materials on this website are provided for informational purposes only and do not constitute legal advice.  Transmission of the information is not intended to create, and receipt does not constitute, an attorney-client relationship between any attorney and any other person, group or entity. No representations or warranties whatsoever, express or implied are given as to the accuracy or applicability of the information contained herein.  No one should rely upon the information contained herein as constituting legal advice.  The information may be modified or rendered incorrect by future legislative or judicial developments and may not be applicable to any individual reader's facts and circumstances.

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[1] Even traders will have to separate out their long term holdings from their trading investments.