Do I meet the requirements for Trader Status or Trader in Securities?

Do I meet the guidelines of Trader Status or Trader in Securities? Well.. um, sure... after all, I am a day trader, right? Unfortunately, your tax professionals guess could be as good as anyone's regardless of what you may have been told or even sold! Don't allow a logical premise to guide you straight into tax court. By doing so, the next trader tax court case could be "[Your Name] V. Commissioner"! Many traders, as well as CPAs, have spent countless hours researching the subject of trader status - to no avail. Why? Because there is no concrete IRS code or regulation outlining the definition of Trader in Securities.

What makes Trader Status so complicated?

Understanding why trader status is so complicated isn't really that complicated. All ethical CPAs and tax attorneys use the I.R.C. or the Internal Revenue Code as a basis for filing a return or expressing a legal opinion. This code provides guidance on tax deductions, accounting methods, and income reporting requirements. However, it completely lacks guidance on the requirements needed to meet trader status or trader in securities.

IRS court cases carve an abstract picture of what the IRS looks for when arguing the requirements of trader status. Precedent from these cases provides some guidance to traders; however, you should never expect a consistent or static ruling from one case to the next. Not a very comforting feeling for a trader is it?

What about IRS Publication 550?

A huge "NO, NO" in the tax profession is to use an IRS publication as a basis for research or tax advice. Even the IRS will admit some of the information contained in their publications is erroneous and should never be substituted for code or regulation. Publication 550 does provide vague information; although, it shouldn't be your sole premise for trader status. The publication states:

To be engaged in business as a trader in securities, you must meet all of the following conditions:

You must seek to profit from daily market movements in the prices of securities and not from dividends, interest or capital appreciation.
Your activity must be substantial.
You must carry on the activity with continuity and regularity.

The following facts and circumstances should be considered in determining if your activity is a securities trading business:

Typical holding period for securities bought and sold.
The frequency and dollar amount of your trades during the year.
The extent to which you pursue the activity to produce income for a livelihood.
The amount of time you devote to the activity.

If your trading activities do not meet the above definition of a business, you are considered an investor, and not a trader. It does not matter whether you call yourself a trader or a "day trader".

Fueling the inferno of Trader Status fallacies

Some trader tax firms market the idea to traders that if they simply use a business entity to trade they will meet trader status. Participating in this fallacy could land a trader in tax court. Again, the last thing you want is your name in our trader tax court listing!

Trading in a legal entity, such as a Corporation or LLC, could provide benefits in the right circumstances. This type of planning requires careful consideration and a full understanding of a traders background in order to solidify justification.

Why do I care about Trader Status?

Meeting "trader in securities" status allows you to treat your trading as a business and deduct all necessary and ordinary business expenses. What's more, you are able to elect the Mark to Market method of accounting. This method of accounting allows you to overcome the $3000 a year loss limitation and eliminates wash sales. In other words, you are able to dramatically slash your tax bill.