Contrary to popular belief, even among tax professionals, simply setting up an entity in which to trade does NOT make that entity a “trading” entity and therefore bypass the trader in security requirements. Otherwise, why wouldn’t every investor do it?
This is a similar argument to having a vehicle painted with a logo, telephone number and other advertising and expect the vehicle to be completely deductible. Well, why wouldn’t it be? Because the vehicle owner still has to substantiate his business usage.
Thus, the trader in securities still has to meet the requirements of a trader and the entity’s investment activities must rise to that same level as well.
The investor versus trader issues have been discussed at length and I would refer you to those.
We are now going to show you various reporting scenarios assuming you have an entity setup in which you are investing or trading.
Examples will be provided for an individual trading in an LLC and secondly, in a flow-through entity, an S-Corporation (Form 1120S), assuming both meet the trader in securities requirements having not made a mark-to-market election.
As suggested in the Entities discussion, stick with flow-through entities unless there is some major overriding consideration to setup a C-Corporation or trust, such as liability protection or family issues.
Tax Reporting and Compliance
Mike made the following trades during 20YY:
300 shares of AAPL
Nov 20YY Short Call; STO $1.20 > Expired
Dec 20YY Short Call; STO $1.95 > Expired
Jan 20YY + 1 Short Call; STO $1.55 > Expired
500 shares of WMT
Nov YY Short Call; STO $0.75 > Expired
Dec YY Short Call; STO $1.05 > Assigned
500 shares of GM
Nov YY Short Call; STO $1.40 > Expired
Dec YY Short Call; STO $1.75 > Expired
Dec YY Long Put: BTO $1.50; STC $0.96
Jan YY+1 Short Call; STO $1.50 > Expired
500 shares of MCD
Jan YY+1 Short Call; STO $1.20 > Expired
500 shares of GE acquired by assignment
Oct YY Short Put; STO $0.75 > Assigned
Nov YY Short Call; STO $0.45 > Expired
Dec YY Short Call; STO $0.65 > Expired
Mike incurred the following expenses related to his securities transactions:
Investment advisory newsletter - $600
Computer - $1,500 (exclusive use); MACRS 5-year
Monitors - $900 (three); MACRS 5-year
Furniture - $750 desk, monitor stand; MACRS 7-year
Software - $360 Microsoft Office 2010; S-L 36 months
Fiber optic data line - $40/month
Airfare & Hotel - $1,300 (for investment conference)
Meals & Entertainment - $200
TOTAL OUT-OF-POCKET EXPENSES - $6,090
Other information for Mike:
Mike has W-2 wages of $48,000 and his spouse has W-2 wages of $60,000
Mike and his wife have three children that are dependents
Mike has itemized deductions of:
Real estate tax - $5,000
Mortgage interest - $10,000
Charitable contributions - $2,500 (cash)
Notes on Trades Presented
Upon examination of the Form 8949's from the 1120S and the 1040 you may be thinking that not all the trades are reported ... and you would be correct!
AAPL Jan 20YY + 1 Short Call; STO $1.55 > Expired
GM Jan YY+1 Short Call; STO $1.20 > Expired
GE Oct YY Short Put; STO $0.75 > Assigned
The AAPL and GM short calls do not close until the following year so they are not reportable.
The GE short put was assigned and therefore reduces the basis of the assigned shares.
Tax Return Presentation
With the above example data and trade notes in mind, take a look at the tax return presentation for each of the two trading entities - one as a Single Member LLC and one as an S Corporation. As you will see, there is no difference in the tax liability (Form 1040, p 2, line 63).
Taxpayer trades in a Single Member LLC and files Schedule C
Taxpayer trades in an S Corporation