Trader Tax Status: Do You Qualify?

02/08/2012 10:15 am EST

Focus: TRADING

Robert Green, CPA

CEO, GreenTraderTax.com

Trader tax specialist Robert Green explains the requirements traders must meet in order to qualify for trader tax status in the eyes of the IRS.

Going back to basics with Robert Green. Robert, let’s talk about the trader tax status, back to basics.

Good, that’s important. Traders each year need to know if they qualify for these tax breaks and what they’re all about.

What are some of the qualifications to get these breaks?

Well, you need to trade 500 round-turn trades a year…it could be a little less; 75% of available trading days, three to four days a week; day trades, swing trades, short holding periods; spend four hours a day; serious account size; tools; home office; and the intention to run a business. 

There’s not a bright line test. It’s defined in case law. The IRS focuses on the frequency of trades on that 500 round trip because they can prove those out.

Good news: this (past) year, we won a big case in that we showed that with the continuous business activity standard, you could trump the frequency of trade. So, if your numbers come up a little short, you can show the IRS that you’ve been working very hard. You have to punch a clock and prove your time, but that’s good news for traders who come up a little short.

How about the tax treatment of futures? How’s that going?

Futures are a wonderful benefit for all traders, including investors.

Why?

You don’t need trader tax status and you still get lower, 60/40 tax rates; 60% is a long-term capital gain, even if it’s just a daytrade. Now Warren Buffett called that a “tax loophole;” in the same article, I was interviewed and I said it’s not¸ and I explained why it’s not. 

Now, members of futures exchanges pay a 15% self-employment tax, but online traders do not, so the taxes are a 12% off sale the regular 35% rate. That’s one-third off; the blended rate is 23%. That is very substantial.

The other good news is that you don’t have a lot of work to do with the accounting. You get a one-page report from the broker and you can use the summary reporting on your tax return.

So, it’s easier to do it, the taxes are lower, but there’s one caveat about the money-protection issue. 

What is that?

Think about the news with MF Global; the old Refco that failed before. There’s no FDIC or SIPC protection. The rule is they segregate the customer funds. Well, tell that to the 23,000 account holders at MF Global. Their customer funds were not segregated.

And that’s illegal, isn’t it?

It’s illegal, but if your money is missing and you can’t get access to it, it’s a problem.

And there’s no protection.

Right. So, keep an eye out for that, but go for those lower taxes and easier reporting.

Do you think the MF Global collapse on top of the Refco demise will cause any type of reform in the futures market?

I think there should be. Why shouldn’t there simply be protection like SIPC? Futures brokers are very similar to securities brokers. These products are very similar to each other. The E-mini Nasdaq 100 is a future. The Nasdaq 100 ETF (QQQ) is a security. Why shouldn’t there be similar protections for investors?

Related Reading:

Related Articles on TRADING