Day Trading & Taxes
Taxes are a complicated hoop for day traders to pass through when reporting profits and losses. Whether you’re trading full-time to make a living or just trying to shore up cash for your long-term savings, there are a variety of tax implications to consider.
Below are the some of the basics about trading and taxes that can help you optimize your trading strategy and best navigate your compulsory payments to Uncle Sam.
Day Trading Taxes — How to File
For those entirely new to financial markets, the basic distinction in tax structure is between long- and short-term investments. Long-term investments, those held for more than a year, are taxed at a lower rate than trades held for less than a year, which are taxed at the normal income rate.
You can see a full breakdown of the rates in the "A Complete Guide To Taxes" section.
For accounting purposes as well as a variety of practical reasons, traders should maintain separate accounts for day trading and building a long-term investment portfolio.
Where to File
Traders must report gains and losses on form 8949 and Schedule D. You can deduct only $3,000 in net capital losses each year. However, if you’re married and use separate filing status, then it’s $1,500.
Traders must provide receipts on the specific trades they claim as losses. And the wash sale rule states you can’t hold shares of that stock 30 days before or after the holding period you wish to claim them on a tax refund.
Schedule C should then have just expenses and zero income. Your trading profits are reflected on Schedule D. To prevent any confusion, you can include a statement detailing your situation.
Any losses over $3,000 can’t be claimed and are simply carried forward as a straight loss.
Trader Tax Status Designation
You might qualify for Trader Tax Status (TTS) if you trade 30 hours or more out of a week and average more than 4 or 5 intraday trades per day for the better part of the tax year.
The designation is not guaranteed. Check out the IRS webpage for more information on TTS. This designation opens up a lot of opportunities for tax efficiency, because professional traders can report their trading income and liabilities as Schedule C business expenses. The direct benefits to this designation include the ability to deduct items such as trading and home office expenses.
Mark-to-Market Trade
The most drastic difference of TTS designation is the ability to deduct losses beyond the $3,000 allowed as capital losses. TTS designated traders must make a mark-to-market election on April 15 of the previous tax year, which permits you to count the total of all their trading gains and losses as business property on part II of IRS form 4797.
Traders who make this election are also exempt from the wash sale rule. Mark-to-market accounting only concerns the total of a tax year’s profits and losses. However, beyond making the election in the previous tax year, traders who choose the mark-to-market accounting method must pretend to sell all holdings at their current market price on the last trading day of the year and pretend to purchase them again once trading resumes in the new year. This is entirely a paper transaction, but has to be done to provide a total accounting of the business assets each year.