Securities Traders Should Get QBI Deduction, CPA Says
FULL TEXT PUBLISHED BY TAX ANALYSTS
Robert A. Green, CPA, firstname.lastname@example.org
I believe a U.S. resident trader in securities with trader tax status, and a Section 475 election for ordinary income/loss, should be eligible for a QBI deduction. Section 199A regs define a trading business as a “specified service trade or business” (SSTB), including trading for its own account. It also includes Section 475 ordinary income/loss in QBI. That indicates potential eligibility for a QBI deduction.
However, Section 199A‘s interaction with Section 864(c) might deny a QBI deduction for traders. The 199A regs indicate if a trade or business does not constitute “effectively connected income” (ECI) in the hands of a nonresident alien under Section 864(c), then it’s not QBI for a U.S. resident taxpayer, even if operating a domestic trade or business. However, “trader in securities or commodities” are covered under Section 864(b)(2), not 864(c).
I hope that tax attorneys in the IRS Office of Chief Counsel will answer this question for traders.
Groups Urge IRS to Rethink 199A Business Income Rules
Above the taxable income cap set for service businesses, owners of trading and investment management companies can’t use the QBI deduction. But for a married trader earning $300,000 a year — just under one of the income thresholds —the couple is entitled to a QBI deduction on service businesses, according to Robert Green of GreenTraderTax.
Green said that before the proposed regulations were released, some other tax experts argued that a hedge fund wouldn’t be a barred service activity in section 199A because technically a management company was providing the service, and the hedge fund was merely receiving it.
Green said that to claim trader tax status and elect section 475 — which treats capital gain and loss as ordinary income and loss — a taxpayer must trade its own funds, and typically a management company would be a partner in a hedge fund and would be trading for the fund.
The proposed regulations clarified that the hedge fund in that scenario wouldn’t qualify for the deduction above the service business income cap. But because section 475 is ordinary income, taxpayers below the thresholds can likely get a deduction on that trading income, because QBI excludes capital gain, Green said.
Green said some managers may decide to receive an incentive fee instead of carried interest of capital gains because the incentive fee is includable in management company QBI, whereas the profit allocation of capital gain is not. The investors may not appreciate that change because they can’t deduct investment fees, but they can get the benefit of a carveout of capital gains, he added.
Attractiveness of S Corporations After 2017
By D. LARRY CRUMBLEY and JAMES R. HASSELBACK, February 26, 2018
Authors based below content on Robert A. Green’s blog posts referenced in footnote 13.
“There are suggestions that trader tax status (TTS) should consider an S corporation for business expenses, and a section 475 election on securities for exemption from the wash sale losses and ordinary loss treatment (tax loss insurance). A TTS S corporation allows employee benefit plan deductions (for example, health insurance and high-deductible retirement plans). The new law is unclear regarding whether section 475(f) 12 income is QBI or a specified service activity. TTS business-related capital gains probably will not be included in QBI.”13
12 - A section 475(f) election (mark-to-market election) allows a trader to treat gains and losses from the sales of securities as ordinary gains and losses (except for securities held for investment).
13 - Robert A. Green, “How Traders Can Get the 20% QBI Deduction Under New Law,” Forbes, Jan. 12, 2018; and Green, “Traders Should Be Entitled to the Pass-Through Tax Deduction,” Forbes, Dec. 12, 2017.