Investor or Trader?

Investors - As "TRADERS"

There are Definite Advantages!

(navigation buttons at the end of the page) pro1040 ©

INSTEAD of using the contents below, you can load this article's table of contents on the left

Question or Topic

You may contact Bob Parrish CPA, P.C. by USA Mail, Fax, telephone or request a meeting

The Question: Are there any advantages to meeting the qualifications for Trader status?

Objectives: Learn the definition of Trader Status and whether there are any advantages in this classification.

Special Rules For Traders In Securities

Investors - "Trader" Definition-Introduction

	The Answer

First Let One Understand the Advantages of The Trader Classification - Opposed to The Investor Classification

(For a short summary of the "Trader" attributes CLICK HERE - you may return to this page by clicking on the previous page button at the top or pressing the Back button on your browser.)

One who profits from securities may be classified as a Dealer, a Trader or an Investor. The dealer will sell to customers and must be registered and licensed by the NASD. The Trader will have no customers. In general and broad terms the Trader will seek profits from speculation over very short trading periods. The Investor will seek profits from long term investing - more than one year and seek dividends and interest to enhance the profits.

The expenses of the Trader may be deducted on Schedule C and not be subject to the limits on itemized deductions. Furthermore, there is the possibility of home office deductions fro the Trader.

The income of the Trader continues to be taxed under the capital gain and loss rules - with one exception as noted below. Furthermore, the income is not subject to the self-employment tax and is included on IRS form 4797.

There next topic will discuss some of the complexities of the mark to market rule. The advantage of the mark to market rule is that all gains and losses can be setoff against one another without concern for the long term or short term classifications. The big disadvantage is the ordinary income treatment. However - the Trader will not usually have long term capital gains. IF the trader does have long term capital gains, then the large differential in the tax brackets must be seriously considered before making the election for the Trader and Market to Market status. Although the Trader's income is taxed at ordinary income rates, the income continues to be exempt from the self-employment tax. The IRS rules provide that "Investment Property" will be treated as capital gain property and will not be included with the "Trader Property". That is Long Term Capital Losses from the Investment Property continue to be subject to the limits for Capital Losses.

Look Now To The Mark to Market Rule Available to the Trader (Not the Investor)

Traders in securities and commodities also may elect to have mark to market treatment apply. Where a person engaged in a trade or business as a trader in securities makes the election, gain or loss on any security held in connection with the trade or business at the close of the taxable year is recognized as if the security were sold at its fair market value on the last business day of the taxable year. The gain or loss is taken into account for that taxable year, and an adjustment is made in the amount of any gain or loss subsequently realized on actual disposition. Code Section 475(f)(1)(A). The same treatment applies with respect to a person who is engaged in a trade or business as a trader in commodities and who makes the election. Code Section 475(f)(2).

The election does not apply to any security that is established to the satisfaction of the Secretary as having no connection to the activities of the person as a trader and that is clearly identified as such in the records of that person before the close of the day on which it was acquired, originated, or entered into. If such a security subsequently becomes connected to the activities of the person as a trader and who has made the election to have the provision apply, any change in the value of the security after it becomes so connected will be subject to the mark to market provisions. Code Section 475(f)(1)(B).

Any security for which the mark to market election has been made and that was acquired in the normal course of the taxpayer's activities as a trader in securities is not taken into account in applying the constructive sales treatment of appreciated financial positions to any position for which the mark to market election has not been made. Code Section 475(f)(1)(C).

The elections made by a trader in securities or a trader in commodities may be made separately for each trade or business and may be made without the consent of the Secretary. Once made, however, the election applies not only to the taxable year for which it was made but for all subsequent years as well. It may not be revoked without the consent of the Secretary. Code Section 475(f)(3).

Elections

Article 99-84. SAMPLE ELECTION TO USE MARK-TO-MARKET ACCOUNTING METHOD

Dealers in commodities and traders in securities and commodities may elect to use mark-to-market accounting by attaching a statement to the timely filed (including extensions) income tax return for the year immediately preceding the election year. The statement must describe the election being made, the first taxable year for which the election is effective, and the trade or business for which the election is made.

Form 3115 must be attached to the timely filed return (including extensions) for the year of change, and a copy of Form 3115 must be filed with the National Office no later than when the return is filed. The form should be labeled "Filed Pursuant to Rev. Proc. 99-17."

Any Code Section 481(a) adjustment should be taken into account ratably over four taxable years beginning with the year of change.

A new taxpayer makes the election by placing the above described statement in its books and records within the first two and one half months of the initial year and attaching the required statement to his first income tax return. Rev. Proc. 99-17, 1999-7 I.R.B. 52.

SAMPLE ELECTION

ELECTION TO USE MARK-TO-MARKET ACCOUNTING METHOD

Name:

SSN#:

Tax Year:

Pursuant to Code Section 475(f) and Rev. Proc. 99-17, taxpayer hereby

elects to use the mark-to-market method for his security [commodity]

trading business. The election is being made for taxable year beginning

[succeeding taxable year].

Adding a Bit of Technical Requirements

Special rules apply if you are a trader in securities in the business of buying and selling securities for your own account. To be engaged in business as a trader in securities, you must meet all 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.

1) Typical holding periods for securities bought and sold.

2) The frequency and dollar amount of your trades during the year.

3) The extent to which you pursue the ac-tivity to produce income for a livelihood.

4) The amount of time you devote to the activity.

If your trading activities are not 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."

Note. You may be a trader in some securities and have other securities you hold for investment. The special rules discussed here do not apply to the securities held for investment. You must keep detailed records to distinguish the securities. The securities held for investment must be identified as such in your records on the day you got them (for example, by holding them in a separate brokerage account).

How To Report

Transactions from trading activities result in capital gains and losses and must be reported on Schedule D (Form 1040). Losses from these transactions are subject to the limit on capital losses explained earlier in this chapter.

Mark-to-market election made. If you made the mark-to-market election, you should re-port all gains and losses from trading as ordinary gains and losses in Part II of Form 4797, instead of as capital gains and losses on Schedule D. In that case, securities held at the end of the year in your business as a trader are marked to market by treating them as if they were sold (and reacquired) for fair market value on the last business day of the year. But do not mark to market any securities you held for investment. Report sales from those securities on Schedule D, not Form 4797.

Expenses. Interest expense and other in-vestment expenses that an investor would deduct on Schedule A (Form 1040) are de-ducted by a trader on Schedule C (Form 1040), Profit or Loss From Business, if the expenses are from the trading business.

Commissions and other costs of acquiring or disposing of securities are not deductible but must be used to figure gain or loss. The limit on investment interest expense, which ap-plies to investors, does not apply to interest paid or incurred in a trading business.

Self-employment tax. Gains and losses from selling securities as part of a trading business are not subject to self-employment tax. This is true whether the election is made or not.

How To Make the Mark-to-Market Election

To make the mark-to-market election for 2001,you must file a statement by April 16, 2001. This statement should be attached to either your 2000 individual income tax return or a request for an extension of time to file that return. The statement must include the following information.

1) That you are making an election under section 475(f) of the Internal Revenue Code.

2) The first tax year for which the election is effective.

3) The trade or business for which you are making the election.

If you are not required to file a 2000 in-come tax return, you make the election by placing the above statement in your books and records no later than March 15, 2001.

Attach a copy of the statement to your 2001 return.

After making the election to change to the mark-to-market method of accounting, you must change your method of accounting for securities under Revenue Procedure 99–49.

Revenue Procedure 99–49 requires you to file Form 3115, Application for Change in Ac-counting Method. Follow its instructions. Label the Form 3115 as filed under "Section 10A of the APPENDIX of Rev. Proc. 99–49."

Once you make the election, it will apply to 2001 and all later tax years, unless you get permission from IRS to revoke it. The effect of making the election is described under Mark-to-market election made, earlier.

For more information on this election, see Revenue Procedure 99–17, 1999–1 CB 503.

	Solutions

Solutions are dependent upon facts & circumstances, law and the objectives. These elements vary from one time to another, from one circumstance to another and from person or entity to another.

Kit to Prepare for Your Adviser