Better Options for Day Traders

The day trading business continues to grow.  As individuals who engage in day trading begin to realize that it can be a career rather than a rewarding hobby, they often begin to consider ways in which they can make the business more profitable.

 

The average individual who invests in the stock market is, from an IRS perspective, an “investor.”  There are strict limits on investors’ ability to deduct losses and the investment expenses they incur.  Since these individuals are merely investing rather than operating a business, they are limited in their ability to deduct losses against taxable income.  Further, investment-related expenses cannot be deducted against income unless those expenses are very high – in excess of 2% of the taxpayer’s adjusted gross income.  Even then, deductions for the expenses relating to the investments may be limited after calculating the taxpayers’ alternative minimum tax (AMT).

“Traders in securities,” on the other hand, have the opportunity to deduct greater amounts of losses and the expenses relating to trading.  The IRS sets a high bar for someone trying to qualify as a trader.  Traders engage primarily in frequent, speculative trading activity, seeking to profit from short-term price fluctuations in the securities traded rather than from dividends, interest or capital appreciation.  Their trading activities must be substantial and carried on continuously and regularly.  In short, a trader devotes a significant amount of time to trading activities and the activities should further the trader’s livelihood.

There is no requirement that traders operate as sole proprietors.  They can form business entities that may offer greater liability protection, provide salaries for themselves and other employees and take advantage of retirement planning opportunities.  Depending on the state where you reside, there may be additional advantages to establishing a business entity in a different state.  Coupling these benefits with the abilities to deduct greater amounts of losses and expenses can result in significant advantages for traders.

Navigating the tax and corporate rules that govern this area can be challenging but they rewards can be substantial.  It is advisable to seek guidance from experienced attorneys and tax professionals who can assist you with determining whether you can qualify as a trader and the appropriate way in which to establish your business venture.