Self- employed trading. Day Trading and Self-Employment Taxes
By Mary Hall Updated Aug 3, As trading becomes more accessible, as a result of the proliferation of online and discount brokerage firms, more people are participating in the stock market.
However, as an individual or sole proprietor, traders cannot take advantage of some of the tax advantages and asset protection strategies that are available to companies. But like any business venture, the income generated from trading is taxable. If you are successful as an independent day trader, it can create significant tax liabilities for you. Individuals that want to actively participate in the stock market have several options: they can trade as individuals or sole proprietorsqualify for trader status, or trade through a business entity.
For the active trader, creating a legal trading business will often provide the best tax treatment and asset protection. Key Takeaways Individuals that want to actively participate in the stock market have several options: they can trade as individuals or sole proprietors, qualify for trader status, or trade through a business entity.
For the active trader, forming a legal trading business will often provide self- employed trading best tax treatment and asset protection. If you cannot qualify for qualified trader status, another way to ensure you are receiving similar tax treatment as compared to a qualified trader is to create a separate corporate entity through which you will conduct your trading activities.
Because trading is not considered a business activity by the IRS, all the expenses necessary to trade are not eligible as tax deductions.
Set up as self-employed (a 'sole trader'): step by step
For most active traders, the costs of necessities—such as education, a trading platform, software, internet access, computers, etc. For most traders, the biggest tax issue they face is that deductions for how much can you earn doing house projects losses are limited to gains.
A qualified trader is allowed to file a Schedule C form and deduct business expenses, which could include education, entertainment, margin interest, and other trading-related expenses. Mark-to-market MTM accounting allows qualified traders to change their capital gains and losses to ordinary income and losses. For the following year, the basis for each of these positions is calculated by assuming they were also purchased at market value.
The hypothetical gains and losses at year-end are added to actual gains and losses for tax purposes. Because gains and losses are regarded as ordinary income under MTM, all losses are deducted in the year they occur. Some traders will also elect MTM to avoid the day wash sale rulewhich disqualifies loss deductions on "substantially identical" securities bought within 30 days before or after a sale.
Traders are individuals who make multiple trades daily to profit from intraday market swings and do so continuously throughout the year. They spend a considerable amount of time documenting and researching trades and strategies and incur a significant amount of expenses to conduct their business.
Although not specifically required, most qualified traders will open and close multiple trades daily and hold their positions for less than 30 days.
SELF EMPLOYED TRUTH!
For active traders, the benefits of self- employed trading are obvious, but these guidelines are open to interpretation by the IRS and the courts.
In reality, only a small percentage of individuals qualify for this IRS status.
Form a Separate Corporate Entity If you cannot qualify for qualified trader status, another way to ensure you are receiving similar tax treatment is to create a separate corporate entity through which you will conduct your trading activities. It is extremely difficult for individuals to change an election, such as MTM, once it has been chosen.
Day Trading and Self-Employment Taxes
With the company, if there is an advantage to changing accounting methods or the legal structure, the entity can simply be dissolved and re-formed accordingly. More Success Equals More Entities For highly successful traders, some financial advisors may suggest forming a business structure that includes multiple entities, as a way of maximizing the tax and protection benefits afforded to the business.
Even though the actual structure is determined by an individual's financial goals, this type of legal business structure usually includes a C corporationwhich exists to be the general partner or managing member of several limited liability companies.
The corporation can then take advantage of deductible salaries and educational expenses, while also building Social Security and Medicare accounts.
Benefits for Active Traders Who Incorporate
Medical reimbursement plans can be created to fund self- employed trading types of elective health care procedures and medical insurance premiums. Retirement accounts such as individual retirement accounts IRAs and k plans can be transferred into a awho deals with options type of pension fund that allows annual contributions and can never be accessed by creditors or through a legal claim.
This type of business structure also provides excellent asset protection because it separates the business from the individual. Long-term assets can be held by other limited liability companies that can use accounting methods better suited for investments. All assets are protected from creditors and the legal self- employed trading of the individual because they are held by separate legal entities.
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However, the amount of legal protection is determined by state law. Many advisors suggest forming the entity in the state of Nevada because of its lack of corporate sales tax, flexibility to change orders as a sole remedy by creditors, the anonymity of not having to list shareholders, and the nomination of corporate officers.
For traders who have been consistently profitable—but cannot or do not want self- employed trading qualify for trader status—trading through a simple business is essential. If you wish to set up a pension fund to defer taxes, pay salaries to loved ones or recoup significant medical expenses tax-free, then the added complexity is a decent trade-off to gain the benefits of a compound structure.
Either way, to receive the best tax treatment and legal protectionit is in your best interest to speak with finance professionals who understand the formation and operation of these entities for traders.
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