Investors - "Trader" Definition/Introduction

Investors - Trader Status Introduction

Special Rules for Traders in Securities

You are a trader in securities if you are engaged in the business of buying and selling securities for your own account. To be engaged in business as a trader in securities:

You must seek to profit from daily market movements in the prices of securities and not from dividends, interest, or cap-ital 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 business.

Typical holding periods 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.

Investing vs. Trading: Traders seek profits by using short-term swings in market prices. A trader is someone who buys and sells frequently. A significant amount of Long Term Capital Gain and Dividends indicates investor status rather than trader status. Short term gains and losses are indicative of a trader. Long term gains do not prohibit the possibility of trader status - one should consider the proportion of each.

Level of Activity: In the presence of short term strategy the trading activity must be substantial and regular. Occasional and irregular intervals of trading do not indicate trader status. One can be a trader without making it a full-time job, but the status may be challenged if the activity is not continuous and at a high enough volume. Personal involvement may be important. If one has a discretionary account and the broker places all the trades for you the activity may be considered an investor even if there's a high volume of short-term activity. However - my personal opinion is that the use of a broker to place your trades does not preclude the trader status. Where you perform the research, you make the decisions for all buy/sell tickets, you make the analysis, etc. the broker is performing only ministerial duties and therefore not involved to the extent of an adviser. Remember that the ultimate question is whether you're engaged in a trade or business

You are considered an investor, and not a trader, if your activity does not meet the above definition of a business. It does not matter whether you call yourself a trader or a “day trader.”

Like an investor, a trader must report each sale of securities (taking into account com-missions and any other costs of acquiring or disposing of the securities) on Schedule D or D-1 or on an attached statement containing all the same information for each sale in a similar format. However, if a trader previously made the mark-to-market election (see below), each transaction is reported in Part II of Form 4797 instead of Schedules D and D-1.

Regardless of whether a trader reports his or her gains and losses on Schedules D and D-1 or Form 4797, the gain or loss from the disposition of securities is not taken into account when figuring net earnings from self-employment on Schedule SE.

See the Instructions for Schedule SE for an exception that applies to section 1256 contracts. The limitation on investment interest expense that applies to investors does not apply to interest paid or incurred in a trading business. A trader reports interest expense and other expenses (excluding commissions and other costs of acquiring or disposing of securities) from a trading business on Schedule C (instead of Schedule A).

A trader also may hold securities for in-vestment. The rules for investors generally will apply to those securities. Allocate interest and other expenses between your trading business and your investment securities.

Mark-To-Market Election for Traders

A trader may make an election under section 475(f) to report all gains and losses from securities held in connection with a trading business as ordinary income (or loss), including securities held at the end of the year.

Securities held at the end of the year 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. Generally, the election must be made by the due date (not including extensions) of the tax return for the year prior to the year for which the election becomes effective.

To be effective for 2000, the election must have been made by April 17, 2000. Starting with the year the election becomes effective, a trader reports all gains and losses from securities held in connection with the trading business, including securities held at the end of the year, in Part II of Form 4797. If you previously made the election, see the instructions for Form 4797. For details on making the mark-to-market election for 2001, see Pub. 550 or Rev. Proc. 99-17, 1999-7 I.R.B. 52. If you hold securities for investment, they must be identified as such in your records on the day they are acquired (for example, by holding the securities in a separate brokerage account). Securities held for investment are not marked-to-market.

The election "Mark-To-Market" decision must not be taken lightly. If the Trader status and your methods consistently and constantly produce short term gains you may find there is very little or no affect on the rate of tax with this election. On the flip side of this coin, if you find a significant portion of your income qualifies for the favorable long term capital gain rate, then you may sadly discover this election costs you a considerable sum in taxes. Furthermore - you must consider the timing of the gains, losses and cash flow to pay the taxes. By using the Mark-To-Market election you will incur tax on gains which have not been converted to cash. You must consider this in your decision making process. As a Mark-To-Market election, there is no limit to the deductibility of losses. When you file using the Mark-To-Market accounting, the year's net losses are "ordinary losses" and are therefore not limited to the annual $3,000 "capital loss" limitation. There is a deadline of April 15 for making this election for the current year. There may be other significant factors - consult Bob Parrish CPA.

Bob Parrish CPA, P.C.

Longboat Key FL; Odessa TX

941-387-0926

LD810-12/01