Business Expense Treatment
If you qualify for trader tax status, you can use the more favorable business expense treatment.
Business traders can deduct all reasonable business expenses, whether they have trading gains or losses, saving around $5,000 per year on average. Business-expense deductions hinge on qualifying for trader tax status (TTS), of course. Investors, on the other hand, are very limited. Investment managers have business expense treatment, too.
The good news is you can still claim TTS for 2016, and even other open tax years (usually up to three years prior). Unlike Section 475 MTM (mark-to-market) accounting, which must be elected by the April 15 deadline, TTS can simply be claimed by a taxpayer after the fact, based on facts and circumstances. If you’re just learning about TTS, you might still be in luck for 2016.
Investors vs. business traders
Unlike business traders, investors are stuck with restricted itemized deductions. Investors can’t deduct pre-business education including most seminars and travel costs, home-office expenses, and start-up costs.
Investment expenses are only allowed as part of “miscellaneous itemized deductions” in excess of 2% of adjusted gross income (AGI), and they aren’t deducted against the alternative minimum tax (AMT). Most itemized deductions are subject to a phase-out for the upper-income brackets (known as the Pease limitation, indexed for inflation); some taxpayers are better off using the standard deduction than the itemized deduction. When you have negative taxable income, investment expenses are wasted, as they don’t carry over to subsequent tax years. Bottom line: Many investment expenses wind up on the cutting room floor. Investment-interest expenses are deductible if they exceed investment income (on Form 4952) and investment expenses, with the excess carried over to the following tax years. With TTS, margin interest paid on business positions is treated as a business-interest expense, which is fully deductible on Schedule C or the separate entity business tax return.
Business deductions include:
- Tangible personal property like a computer, up to $2,500 per item, providing you file a Sec. 1.263(a)-1(f)) safe harbor election with your tax return.
- Section 179 (100%), bonus, and or regular depreciation on computers, equipment, furniture and fixtures.
- Amortization on start-up costs (Section 195), organization costs (Section 248) and software.
- Education expenses paid and courses taken after commencement of your trading business activity. Otherwise, pre-business education may not be deductible, or it may be included in Section 195 start-up costs.
- Books/publications, market data, online and professional services, chat rooms, mentors, coaches, supplies, phone, travel/entertainment, seminars, conferences, assistants, consultants and more.
- Home-office expenses for the business portion of your home (share of rent, mortgage interest, real estate tax, depreciation on home, utilities, repairs, insurance and all other home costs).
- Margin interest expenses (not limited to investment income).
- Stock borrow fees for short sellers.
Business deductions don’t include:
- Cars. Vehicles aren’t usually deductible for at-home traders, because traders don’t need a car to visit clients or companies.
- Commissions. These are deductible against your trading gains and losses.
For more in-depth information about business expenses for traders, including special rules for education expenses, startup expenses, home office and other expenses, read Green’s 2017 Trader Tax Guide.