Tax Planning for Day Trading
You are a day trader if you buy and sell security within a single day. It can make for a profitable job if you are experienced and a skilled investor. Day trading on the stock market involves capitalizing on the rise and fall of stock prices. The objective for a day trader is to have these trades result in a net profit over the time span of a year. Meaning you will be paying taxes on these profits.
New investors find day trading appealing and as an efficient way to earn money quickly. Again, you make money by making trades over short periods and taking advantage of short-term price changes.
You should also be aware this type of occupation also can bring about tax and accounting challenges that could be overwhelming to a typical day trader or investor. In fact, it is important whether you classify yourself as a trader or an investor when it comes to paying taxes.
Day traders, in particular, have various ways to reduce their taxes. Utilizing special benefits that can be optimized is key to legally minimizing your tax liability.
Ways to Reduce Your Taxes as a Day Trader
Mark-to Market Accounting
If you are considered a day trader by the Internal Revenue Service (IRS), then you are able to benefit from a tax filing option known as mark-to-market accounting. This is a method involving reporting gains and losses as if you sold everything on the last day of the year. This translates into you marking the securities held to the end-of-the-year market value. This is accomplished at the end of every tax year.
The benefit comes in that net trading losses are able to be deducted against other income on an unlimited basis. This is in stark contrast to normal taxpayers who have to abide by a $3,000 limit when paying taxes on ordinary income.
It is worth noting that the earnings you realize from day trading fall into a short-term capital gain tax rate as taxable income, as opposed to being treated as long-term capital gains. For the most part, long-term capital gains usually have a lower tax rate than short-term capital gains.
Short-term capital gains is when you make a profit on the sale of an asset that has been held for up to one year. Long-term capital gain applies to assets held for longer than one year.
Mark-to-market traders start a new tax year with a “clean slate.” This means that all positions have zero unrealized net gains or losses. Conversely, day traders are not able to use the preferable capital gains tax rates for long-term capital gains.
Deductions for Expenses Related to Day Trading
Just like any other business – as the IRS considers your day-trading status to be – day traders can deduct their operating costs. Deductions could include the following:
- Office supplies
- Home office
- Rented office space
- Cost of equipment such as digital devices, computers, Internet access
- Accounting costs
Being Exempt from Wash Sale Rules
What is a wash sale? A wash sale involves selling a stock at a loss and then repurchasing the same stock within a short amount of time. The IRS has defined the time period as 30 days. The IRS stipulates the repurchased security does not have to be identical, but substantially similar. This also applies to a spouse or a business partner repurchasing the security.
The wash rule is designed to prevent retail investors from selling a security for a loss and turning around and repurchasing the security shortly into the new year. However, the wash rule does not apply to people categorized as day traders by the IRS.
If a day trader chooses to sell a specific stock at a loss to claim a higher loss on their tax return, which reduces their overall tax liabilities, that is an acceptable tax strategy. Nonetheless, if a day trader not only trades stocks on the market, but also participates in options trading, they may need to become familiar with the finer points of stock options sales taxes.
Benefit from Not Being Subject to Self-Employment Tax
In contrast to other Schedule C taxpayers, the day trader’s profits are not subject to the self-employment tax. This tax consists of the Medicare tax and the Social Security tax for people who work for themselves. Day traders are not able to use this income as the basis for making business retirement plan contributions.
What is a Day Trader in the Eyes of the IRS?
You might be surprised to learn that working as a day trader does not necessarily qualify you to have the tax status of a trader. The IRS considers you a trader if you meet the following specific criteria:
- You intend to profit from daily price fluctuations of securities versus from dividends,
interest, or capital appreciation from the securities.
- You must participate in this trading activity on a continuous and regular basis.
- Your activity is considered substantial in the view of the IRS.
What’s more, the IRS will examine the following factors to determine if your trading activity is a securities trading business:
- The frequency and dollar amount of your trades during the course of the year.
- Your usual holding period for the securities you purchase and sell.
- The amount of time you dedicate to your trading activity.
- The extent to which you pursue this trading activity to generate income and provide a livelihood for yourself.
If your trading activities don’t satisfy these criteria as established by the IRS, then the IRS will probably consider you an investor.
Look to Drilldown Solution for Expert Tax Planning Services for Your Small Business
Drilldown Solution delivers a seamless tax planning and compliance process. As is the case with all of our programs, tax planning solutions are custom-made based on an individual’s needs, wants, and the goals of your business. You can expect your business to greatly benefit from our dedicated team of tax experts, ensuring that your tax planning needs are met quickly and efficiently.
At the core of our tax planning services is the promise to you that we will devise a tax strategy aimed at reducing your liabilities and optimizing profits for your business.
Our Provo, Utah Tax Planning Services are just what your small business needs.
Drilldown Solution Can Help Your Small Business Accounting Needs
Our accounting services are designed to reduce your administrative and bookkeeping burdens and provide you with valuable financial benchmarks for your business. This results in keeping you updated and informed.
Our seasoned, highly skilled full-service accounting team at Drilldown Solution will remove your financial pain points with bookkeeping to make managing your money easier. DrillDown Solution has the important tools you require to track expenses, oversee cash flow, and discover financial trends so you can effectively plan for the future of your business.
We have the expert team to help any small business thrive, even under the current COVID-19 pandemic circumstances. We accomplish this with a three-part system comprised of patient-experience excellence, financial focused operations, and accountability.
Our goal at Drilldown Solution is to put your small business in the best financial position possible, utilizing proactive processes and personal care!