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In this section we will assist you in determining your status as an investor or trader.  The results can have a significant impact on your tax liability.

The determination dictates how gains and losses are recognized and under which [Internal Revenue] Code Section your expenses are deducted:

 

  • Investors - Code Sec 212 and deducted on Schedule A as Miscellaneous Itemized Deductions subject to a 2% of Adjusted Gross Income threshold

  • Traders - Code Sec 162 and deducted on Schedule C

Regardless of which section you qualify under, your income is not subject to self-employment tax.

Dual Status

You can have both investor and trader status simultaneously but it will be in two separate brokerage accounts.

Investor vs Trader

Mark-To-Market Trader

If you have determined you are indeed a trader, there are still some disadvantages you will face, namely:

•  the annual capital loss limitation of $3000, and
•  the wash sale rule

 

By electing Mark-To-Market, you can eliminate these two restrictions.  Please refer to the discussion on Mark-To-Market trader status.

Trading Inside an Entity

An investor/trader may setup an entity under their respective state rules and trade within that entity.

Why should this be considered?

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 obtain some other benefit plan such as health insurance

However, I have heard the comment "just setup an entity and deduct everything" on many occasions.  This could not be further from the truth.

Just setting up an entity does NOT necessarily entitle you to deduct a number of “ordinary and necessary” business expenses that you would otherwise NOT be entitled to if NOT trading inside an entity.

 

If you do 50 (or even 350) trades inside your entity and then deduct your auto, home office “for the convenience of your employer,” provide other employee fringe benefits, etc., you may have some serious questions to answer from the IRS and/or your state revenue department.  This will be discussed in more detail in the Entity section.

Types of Traders