Who is Stock Trader for IRS and who can claim stock Trader Tax Status (TTS)

 

Stock Trader Tax Status (TTS) and Mark-to-Market (MTM) Election


Let’s first discuss type of individual who buys and sells securities wearing different hats.

Investors:

Investors buy and sell security with an intension to income from dividend, interest and capital appreciation. They hold security for longer period. They are investors and are not in trading business. Investors hold their security for a substantial period of time. Sometimes, even forever. When the security is sold the gain or loss will generally be capital gains shown on Schedule D of form 1040 and on form 8949.Investment income is not subject to self employment taxes neither the investment expenses are deductible on the individual tax return. Investor are also limited to capital loss limitation. However, capital losses can be set off against capital gains.

Dealers:

Dealers can be individual or a business entity. Dealers purchase and buy stocks on behalf or for their customers regularly. Sometimes dealer maintains inventory of stock that they assign or sell to the customers. Dealer should maintain record that clearly identifies the securities held on personal capacity or bought for the customer or for business use. If you are engaged on providing services of buying or selling of stock and helping customers to make a buying or selling decision and charge commission or get paid for it , then you should be registered with SEC.

Traders

Who is a Stock Trader?

Trader is one who buys and sells security as his primary business on a regular basis.

There are special rules for traders in security. You must be trading for yourself and not for or on behalf of the customers.

You are trader if you meet all of the following conditions:

ü  You must seek to profit from daily market movements in the prices of securities and not from dividends, interest, or capital appreciation;

ü  Your activity must be substantial; and

ü  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:

ü  Typical holding periods for securities bought and sold;

ü  The frequency and dollar amount of your trades during the year;

ü  The extent to which you pursue the activity to produce income for a livelihood; and

ü  The amount of time you devote to the activity.

If you do not satisfy the conditions, you are investor and not a trader. You can even have investment securities and trading securities if you could maintain detail records to distinguish investment and trading securities even in the same brokerage account. However holding them in separate brokerage account make it easier for record keeping.

You can deduct your trading expenses as business expenses on schedule C.

In essence anyone who does continuous trading are qualified for Stock Trader Status. Mostly day traders are easily qualified. If you can show that you participated in the trading substantially that will qualify you. If you have a full time job, that will be little tricky. But rules does not prevent you to elect Trader Tax Status. Rule does not specify number of traders, hours you put in, amount you trade. However, the trade should be regular and substantial plus it should be your primary occupation. Make profit or loss that does not matter.

The Mark-to-Market Election (MTM)

Traders can choose to elect mark to mark election. Once the mark to mark election is made the gain or loss from the securities are treated as ordinary gains and losses expect the security held for investment. The gain or loss is reported on form 4797 instead of Schedule D. In this situation neither the capital gain loss limitation nor the wash sale rules apply to the trader using mark to market method of accounting.. All the gains and losses become ordinary.

Valid MTM election under sec 475(f) must be made by the original due date of tax filing of the prior tax return. If you are electing MTM for 2023, it must be filed within your original due date for filing 2022 tax returns.  You can also file MTM with extension of your tax returns.

You make MTM election by attaching a statement to your income tax return or to a request for an extension to file your return. The statement should include the following information:

1.     That you're making an election under section 475(f);

2.    The first tax year for which the election is effective (that is, the tax year for which a timely election is being made); and

3.     The trade or business for which you're making the election.

Generally, late section 475(f) elections aren't allowed.

After making the election to change to the mark-to-market method of accounting, you must change your method of accounting by filing form 3115.

Once you elected MTM the only way to stop using mark-to-market accounting for securities is to file an automatic request for revocation to IRS. The request for revocation must be filed by the original due date of the return for the taxable year preceding the year of change. This revocation notification statement must be attached to either that return or if applicable, to a request for extension of time to file that return. Late revocations won't generally be allowed.

 

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