2016 individual tax returns are due April 18, 2017. But, most active traders aren’t ready to file on time. Some brokers issue corrected 1099Bs close to, or after the deadline. Many partnerships and S-Corps file extensions by March 15, 2017, and don’t issue Schedule K-1s to investors until after April 18. Many securities traders struggle with accounting for wash sale loss adjustments and they aren’t ready to file.
Traders face more complexity than employees with easy-to-report W-2 income, portfolio income, and itemized deductions. Traders have involved trade accounting issues, trader tax status analysis and reporting strategies, business vs. investment expenses, and other unique considerations.
Good news: Traders don’t have to rush completion of their tax returns by April 18. They should take advantage of a simple one-page automatic extension along with payment of taxes owed the IRS and state. Most active traders file extensions, and it’s helpful to them on many fronts.
Six-month extension of time to file
Request an automatic six-month extension of time to file individual federal and state income tax returns by Oct. 16, 2017. Form 4868 instructions point out how easy it is to get this automatic extension — no reason is required. It’s an extension of time to file a complete tax return, not an extension of time to pay taxes owed. In good faith, estimate and report what you think you owe for 2016 based on your tax information received.
Avoid penalties from the IRS and state for being late
Learn how IRS and state late-filing and late-payment penalties apply so you can avoid or reduce them to your satisfaction. See 2016 Form 4868 page two for the full explanation of federal late-payment penalties and late-filing penalties, including how taxpayers may request penalty abatement.
File a return or automatic extension on time even if you can’t pay what you estimate you owe. In most cases, the late-filing penalty is ten times more than the late-payment penalty. So if you can’t pay in full, you should file your tax return or extension and pay as much as you can.
An example of late-payment and late-filing penalties
Assume you estimate your 2016 tax liability is $50,000. Suppose you file an extension by April 18, 2017, but don’t pay any of your tax balance due. You file your actual tax return on the extended due date of Oct. 16, 2017, with full payment. A late-payment penalty applies because you did not pay 90% of your tax liability on April 18. The late-payment penalty is $1,500 (6 months late x 0.5% per month x $50,000). Some traders view a late-payment penalty like a 6% margin loan. I’ve seen traders skip an extension payment to trade the tax money longer, only to lose it and cause bigger tax penalties. That’s risky.
By simply filing the extension on time in the above example, you avoided a late-filing penalty of $11,250 (6 months late x 5% per month (25% max), less late-payment penalty factor of 2.5%, equals a net late-filing penalty of 22.5% x $50,000). Interest is also charged on taxes paid after April 18.
Add a payment cushion for Q1 2017 estimated taxes due
Traders with 2017 year-to-date trading gains should consider making quarterly estimated tax payments during the year to avoid underestimated tax penalties. For 2016, a 4% rate applies for the following periods — April 16 through June 30, July 1 through September 30, October 1 through December 31, and January 1, 2017, through April 15, 2017. (See Underpayment Penalty for 2016.)
I recommend the following strategy for traders and business owners: Overpay your 2016 tax extension on April 18, 2017, and plan to apply an overpayment credit toward Q1 2017 estimated taxes. Most traders don’t make estimated tax payments until Q3 and or Q4 when they have more visibility on trading results. Why pay estimated taxes for Q1 and Q2 if you incur substantial trading losses later in the year?
It’s a better idea to pay an extra amount for the extension. That would give three good choices: A cushion on 2016 if you underestimated your taxes, an overpayment credit toward 2017 taxes, or a tax refund for 2016 if no 2017 estimated taxes are due.
Congress is considering changes to Obamacare taxes
The IRS recently announced a change of course: It will accept “silent” 2016 tax returns, where the taxpayer does not check the box for having ACA-compliant health insurance coverage or a qualified exemption from the Affordable Care Act’s individual health insurance mandate and shared responsibility payment. The IRS said it still expects taxpayers to comply with all ACA taxes, including this shared responsibility payment. ACA taxes include Form 8962 (Premium Tax Credit) where a taxpayer may owe the IRS a “Repayment of Excess Advance Payment” (a clawback) if the taxpayer’s income is higher than estimated in applying for government subsidies on a health insurance marketplace or exchange.
President Trump issued an “Executive Order Minimizing the Economic Burden of the Patient Protection and Affordable Care Act Pending Repeal,” and it applies to the IRS. The White House and Congress are working on an ACA “repeal and replace” bill, and the House’s current version included repeal of the ACA individual health insurance mandate and shared responsibility payment, valid for the tax year 2016 and subsequent years. It’s wise to file an extension to wait and see the outcome of these potential changes.
Don’t get your hopes up for a retroactive repeal of the ACA 3.8% Net Investment Tax (NIT) on unearned income. The House bill calls for repeal of NIT beginning in 2018, so NIT should remain for 2016 and 2017.
Section 475 MTM elections
Individual, sole proprietor traders qualifying for trader tax status should consider a Section 475 MTM election for ordinary gain or loss treatment by the due date of April 18, 2017. Ordinary losses generate tax benefits faster than capital loss carryovers. Attach a Section 475 election statement to the federal Form 4868 and mail it by April 18, 2017, certified return receipt. You can’t e-file an extension with this election statement attached. You can elect Section 475 on securities only, or Section 1256 contracts, too. (Learn more about Section 475 in Green’s 2017 Trader Tax Guide, Chapter 2.)
Other benefits from filing extensions
Sophisticated and wealthy taxpayers know the “real” tax deadline is Oct. 16, 2017, for individuals and Sept. 15, 2017, for pass-through entities, including partnership and S-Corp tax returns. Pass-through entities file tax extensions by Mar. 15, 2017. (See March 15 Is The Tax Deadline For S-Corp And Partnership Extensions And Elections.)
You don’t have to wait until the last few days of the extension period like most wealthy taxpayers. Try to file your tax return in the summer months.
I’ve always advised clients to be aggressive but legal with tax-return filings and look conservative with cash (tax money). Impress the IRS with your patience on overpayment credits and demonstrate you’re not hungry and perhaps overly aggressive to generate tax refunds. It’s a wise strategy for traders to apply overpayment credits toward estimated taxes owed on current-year trading income. You want to look like you’re going to be successful in the current tax year.
The additional time helps build tax positions like qualification for trader tax status in 2016 and 2017. It may open opportunities for new ideas on tax savings. A rushed return does not. For example, a significant trading gain or loss during the summer of 2017 could affect some decision-making about your 2016 tax return.
More options for retirement planning
The extension also pushes back the deadline for paying money into qualified retirement plans including a Solo 401(k), SEP IRA and defined benefit plan. The deadline for 2016 IRA contributions is April 18, 2017. If you did a Roth IRA conversion in 2016, the extension gives you six months of additional time to recharacterize (unwind) the conversion. That may come in handy if the stock market drops in Q2 and Q3 2017.
Working with accountants
Your accountant can prepare extension forms quickly for a nominal additional cost related to that job. There are no fees from the IRS or state for filing extensions. Be sure to give your accountant tax information received and estimates for missing information.
Your accountant begins your tax compliance (preparation) engagement, and he or she cuts it off when seeing a solid draft to use for extension filing purposes. Your accountant will wait for final tax information to arrive after April 18 to complete your tax return. Think of the extension as a half-time break. It’s not procrastination; accountants want tax returns finished.
Please don’t overwhelm your tax preparer the last few weeks and days before April 18 with minor details on your tax return in a rush to file a complete tax return. Accounting firms with high standards of quality have internal deadlines for receiving tax information for completing tax returns. It’s unwise to pressure your accountant, which could lead to mistakes or oversights in a rush to file a complete return the last-minute. That doesn’t serve anyone well.
Securities traders should focus on trade accounting
If you know you’ll have a capital loss limitation of $3,000; it doesn’t matter if your capital loss is $50,000 or $75,000 at extension time. Either way, you’ll be reporting a capital loss limitation of $3,000 against other income. In this case, don’t get bogged down with trade accounting and reconciliation with Form 1099Bs until after April 18.
Consider wash sale loss rules. If you know wash sale loss adjustments won’t change your $3,000 capital loss limitation, you can proceed with your extension filing. But if you suspect wash sale loss adjustments could lead to reporting capital gains rather than losses, or if you aren’t sure of your capital gains amount, focus your efforts on trade accounting before April 18.
For Section 1256 contracts, you can rely on the one-page 1099B showing aggregate profit or loss. For forex, you can depend on the broker’s online tax reports. Wash sales don’t apply to Section 1256 contracts and forex.
Some states don’t require an automatic extension for overpaid returns; they accept the federal extension. If you owe state taxes, you need to file a state extension with payment. States tend to be less accommodating than the IRS in abating penalties, so it’s usually wise to cover your state taxes first if you’re short on cash. Check the extension rules in your state. They probably have good online information.
U.S. citizens or resident aliens residing overseas are allowed an automatic two-month extension until June 15, 2017, to file their tax return and pay any amount due without requesting an extension. Excerpt from the IRS website: “If you are a U.S. citizen or resident alien living and working (or on military duty) outside the U.S. and Puerto Rico, file your 2016 income tax return (Form 1040) and pay any tax due (by June 15, 2017). If you want a 4-month extension of time to file your return, use Form 4868 to extend your filing deadline to October 16. (Note that there are special provisions for military personnel who are stationed in a combat zone. For more information, see IRS Publication 3.)”