Entities

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Trading Inside an Entity

Entity Selection

Entity Setup

An investor/trader may setup an entity under their respective state rules and trade in it. Here is the general process:

1. Setup the new entity - online* - under your domicile state rules
2. Obtain a taxpayer identification number from IRS, again, online
3. Setup a new account at your broker titled exactly as the new entity is titled. For example, if your new entity is called “Make Big Money, LLC” with your state, the account name at your broker should be titled “Make Big Money, LLC”
4. Consider setting up a bank account, if you can get one for little or no monthly fees, with the same title
5. Transfer your security holdings into the new entity at the broker
6. File a tax return for the new entity, depending on the type of entity formed (see below)

Why should you do this?

This is a short question but there are a myriad of answers, some of which could be:

• You barely qualify or do not qualify for trader status, using conservative qualification criteria discussed in the Trader section
• You do qualify for MTM trader status but missed the election deadline
• You want to fund a retirement plan or other benefit plan such as health insurance

Keep in mind, this is a serious undertaking. Now you have another entity you must manage and report to various state and federal agencies regarding.

Also, just setting up an entity does not necessarily entitle you to deduct a number of “ordinary and necessary” business expenses. If you do ten trades in you entity and deduct your auto, home office “for the convenience of your employer,” employee benefits, etc., you will have some “... serious ‘splaining to do ...” with the IRS and/or your state revenue department.

So, you’ve decided you want/need an entity. What now?

Quick Links to:
• Entity Selection
• Entity Setup
• Entity Reporting
• Benefits

Entity Reporting

Sole Proprietorship

• Really not a separate entity but represents the default for a trader

• No liability protection, which can have implications for traders

• Subject to self-employment tax at 15.3% of Net Earnings from Self Employment (Note: Simply trading as a sole proprietor is not subject to self-employment tax since trading income is not “earned” income)

• A trader will show no gross receipts or sales which can be an IRS “red flag” unless properly disclosed

Corporation

• Two types: C Corporation (default) & S Corporation (elected)
• C Corporation:
◦ Provides potentially less cumbersome benefits for owners

◦ Corporations result in potential double taxation for employee/shareholder

◦ Pays its own tax

• S Corporation:

◦ Status must be elected after forming corporation (filing Form 2553)

◦ Flow-through entity taxed on shareholder’s individual income tax return

◦ Benefits similar to C Corporations but reporting complexity

◦ Proper planning can minimize FICA (Social security & medicare)

◦ If not a personal services corporation then no self-employment tax

Partnership

• Little or no liability protection for general partners
• Limited partners do enjoy limited liability, up to their investment
• No income tax paid at entity level
• Net income flows through to partners
• Default entity for husband-wife trading operation

• Trading income not subject to self-employment tax, whereas flow-through from a partnership to general partners usually is subject to self-employment tax

Limited Liability Company

• Owners are “members”
• May have single or multiple members

• Under the “check-the-box” IRS regulations, may elect to be taxed as a sole proprietorship (default for single member LLC), partnership (default for multi-member LLC) or corporation

• If corporate status elected (file Form 8832), default is C Corporation but may also elect S Corporation status (file Form 2553 with Form 8823)

• Provides owners with limited liability

Which should you choose?

Each entity has its own advantages and disadvantages. However, here are some general principles to help you decide.

1. Check with your state to determine if reporting requirements exist for a particular type of entity.

2. Does your state require a formal agreement? General partnerships may or may not, limited partnerships probably will and corporations and LLC’s definitely will.

3. Keep it simple. Do not setup an entity you do not fully understand! It will cost you money to set it up and if you decide to change it will cost you more.

4. Stick with flow-through entities such as partnerships, LLC’s and S Corporations. This way your new trading entity will not owe tax itself.

If you have decided to stick with a sole proprietorship then you need not read any further, you’re set!

If you have checked with your state and you need a formal agreement or need to organize under their regulations, you can typically use the following service to accomplish this. I have used them and they are quick and one of the least expensive. You will pay your state fees plus less than $150.

Click one of these to setup your trading entity. SmallBiz.com is a little less expensive and legalzoom.com is the most popular.

To keep your setup expenses lower, you may obtain you taxpayer identification number yourself. If you decide to elect S Corporation status you may need a professional to file your corporate election (if you are an LLC) or to prepare Form 2553, but you can complete those yourself also.

Here are the steps for obtaining a taxpayer identification number.

The entities mentioned above will file different types of tax returns, all of which have their own nuances and difficulties. These are only the possible Federal tax return forms that will be filed and their respective due dates and extended due dates. Each state will have its own tax return forms.

Entity Type

Form(s)

Due Date

Extend To

Sole Proprietor

1040 Sch C, Sch D, Forms 4797& 6781

April 15

October 15

Partnership

1065/Sch K-1

April 15

September 15

LLC

1040 Sch C/1065/1120/1120S

March 15
April 15

September 15
October 15

C Corporation

1120

March 15

September 15

S Corporation

1120S/Sch K-1

March 15

September 15

Benefits

The primary “benefits” of trading inside an entity are just that, the provision of employee benefits.

Entities treated as corporations have a wide variety of benefits available to them:

• Retirement benefits

◦ Defined benefit plans - unlikely because of excessive compliance

◦ Defined contribution plans - 401(k), SIMPLE

◦ Profit-sharing and pension plans - SEP

• Employee fringe benefits

• Health/medical insurance plans

• Education assistance plans

• Working condition fringe benefits

Partnerships, LLC’s reporting as partnerships and sole proprietors cannot classify partners and owners as employees. In order to establish retirement benefits one has to have earned income. Earned income, ie, W-2 wages, necessitates the withholding of employment taxes, which leads to more compliance, in the form of:

• Form 941 - quarterly; 7.65%

• Form 940 - annually; 0.8%

• Form W-2/W-3 - annually

• State unemployment - quarterly; 0.23% - 7.3%

An extensive treatment of benefits is beyond the scope of this website. However, it is a major discussion point in the determination of attaining trader status and choosing the right entity for your needs. Some of the more desirable benefits are discussed here.

Some brokerages may not allow real-time quotes for trading entities other than those setup as individuals. The exchange rules apparently deem any entity other than an individual as a “professional” and will charge your brokerage a fee for providing real-time quotes. The broker will then pass those fees on to you, which can exceed $200 per MONTH!!

Be sure to determine if this applies to you and if there is a remedy for it BEFORE you setup your entity.