Traders Taxes -- Income Tax Returns
The IRS will also look at the frequency and dollar amount of your trades; how long you held the securities; the extent to which trading is used to make income for your livelihood; and the amount of time you spend on trading. Basically this means you must not be a part-time trader.
The difference for an individual taxpayer as to whether they are in the business of a trader or simply an investor is in the treatment of trading expenses. The gains and losses are treated the same and are reported as capital gains and losses on Form 1040 Schedule D. Emini futures traders must also complete Form 6781 which is discussed below.
If you are classified as an "investor", your trading expenses are deducted as an itemized deduction on Schedule A but only to the extent they exceed 2% of your Adjusted Gross Income. The 2% rule will greatly limit the amount deductible for most taxpayers.
If you are classified as being in the "trading business", your trading expenses are fully deductible as a business expense on Schedule C and not limited by the 2% rule.
The Internal Revenue Service (IRS) trader income tax return rules have always been somewhat complicated and unclear. The first thing is to determine if you are in business as a "trader in securities".
The emini S&P and all other emini futures do qualify as securities. This discussion focuses on the emini futures but generally is the same for all securities.
To be in the business as a trader in securities, you must seek to profit from daily price movements in securities -- not from appreciation, interest or dividends. Your trading must be substantial with continuity and regularity.
The only time when your trading gains and losses are not considered capital gains and losses is when you make what is known as a Mark-to-Market Election.
This has the effect of treating all open transactions at the end of the year as being closed at the year-end market price. The gains and losses are then treated as ordinary and reported on Form 4797.
Capital losses on Schedule D can only be deducted up to $3000 per year from ordinary income, ie. salary income, etc.
Losses on Form 4797 though, do not have the $3000 limitation. Long Term Capital Gains however enjoy a lower tax rate than ordinary gains on Form 4797. You can see that this gets rather complicated.
But if you are an emini daytrader or a stock daytrader, you will not have any open positions at the end of any year and therefore a Mark-to-Market Election will have less significance for you.
Trading gains and losses whether as an investor or in the business of trading are not subject to the self-employment tax which is really a combined social security and medicare tax.
The bad news is that you cannot make a retirement plan contribution based upon your trading. The IRS does not consider trading gains as "earned income", which is a prerequisite for making a contribution. This includes any contribution to an Individual Retirement Account (IRA); 401K Plan; Simplified Employee Pension Plan (SEP); or any other type of pension plan.
You can though, contribute to a retirement plan if your trading business is set up as a separate entity such as a corporation. Your trading gains could then be paid to yourself as a salary, which qualifies as earned income.
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At the end of the year you will receive a Form 1099-B Proceeds From Broker and Barter Exchange Transactions from each broker where you had a trading account.
For emini futures traders, the amount in box # 11 must be entered in Part I, line 1on Form 6781 Gains and Losses From Section 1256 Contracts. In line 1 write in the name of the broker and include the amount in the gain or loss column.
The total gains and losses are netted and shown on line 5. The short term capital gain or loss will equal 40% of line 5. The long term capital gain or loss will be 60% of line 5. These amounts are entered on lines 8 and 9 and then transferred to Schedule D.
Trader Tax Returns - Trading Business - Qualify For a 401k and IRA - Form 6781