How to pick stock? and How to trade successfully? |
Are you a trader or an investor? The IRS wants to know
Differentiating yourself as a trader can have a big impact on your pocketbook come
tax time.
Just ask Richard Joyner, a CPA and president of wealth management for Tolleson
Wealth Management in Dallas, who recently shed some light on this critical issue
for Trading Digest.
By definition, a trader is someone who invests frequent, regular and continuous
personal involvement to his or her trading activity, and it is his or her primary source
of income, according to Joyner.
Review your account balances
“They are looking at charts for short-term trends and are making investment
decisions based on short-term swings in the market,” Joyner said. “For example, a
trader may buy and sell oil stocks to take advantage of short-term swings in oil
prices. This would imply that the holding period for stocks is short. By comparison,
an investor may by an oil stock and keep it for five years.”
Joyner said a trader does not hold onto stock for six months, a year or five years.
An investor, on the other hand, is someone who only trades once or twice a year
and it is not his or her primary source of income. Therefore, an investor’s tax
deductions will not be as advantageous as a trader’s.
Trader vs. Investor tax advantages
A trader’s business expenses are fully deductible and not subject to limitations of
investment interest. Joyner said those same expenses, as an investor, are limited
and only deductible “to the extent that they exceed 2 percent of your adjusted gross
income.”
“Generally, if you are comparing an investor and trader for tax purposes, it’s going to
be a facts and circumstances test,” he said. “Not a check list. The weight of the
evidence will determine if you are one or the other.”
However, Joyner said it is possible to be both. As an example, he said if you have
$10 million and want to trade half and invest half for the next 20 years, expenses on
the trader portfolio are considered trader, and expenses on the investment portfolio
are classified as investor.
“It’s the weight of the evidence,” he said. “You need to look at the facts and consider
the facts.”
The weight of the evidence Joyner refers to is a trader’s documentation and
business records.
“What you need to bring to a CPA is probably different than what you will need to
bring to the IRS,” he said.
Should you find yourself in front of the IRS proving your position as a trader, Joyner
said the most important things to present are your trading records, copies of
monthly statements and confirmations, profit and loss statements and a balance
sheet of activities.
“That will allow them to see the frequency of trades, how long you held the stocks
and help them infer what kind of trades you are doing,” he said. “If you expect to be
treated as a business, then keep the records a business would keep. If you don’t
have any formal accounting records, the IRS will not look as favorably on that as they
would if you come in with a full set of accounting records.”
Review your account balances
Also, having a separate checking account for trading will bode well with the IRS.
“If you have a trading business and trade it out of your personal checkbook, it doesn’
t look like a business,” he said. “Have a separate checking account and pay all
trading expenses out of that account.”
Tax deductions a trader can expect include regular home office expenses, rent if
leasing office space outside of the home, and computer costs. A trader can deduct
all utilities, office insurance, and professional fees for consultants and accountants.
However, he cautions traders with the ‘wash-sale rules.”
“If a trader sells a stock at a loss and then re-buys that stock within 30 days of the
sale date, recognition of the stock loss is deferred,” he said.
Joyner said if, as a trader, you expect the IRS to treat you as a business, than you
have to run it that way.
“If you get called to an audit and have purchased research to research your strategy,
this would support the fact that you are a trader to the IRS and that your trading
activities are done more formally, as a business would operate,” he said.
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