Author Archives: Robert Green

How Some Traders Double-Up On Retirement Plan Contributions

June 23, 2021 | By: Robert A. Green, CPA | Read it on

Profitable traders are keen on maximizing retirement plan contributions in trading activities and also in their full-time jobs. Traders are pros at investing, and they understand the power of tax-free compounding while saving for retirement. However, wages are required to make contributions to a retirement plan.  Active traders eligible for trader tax status (TTS) can use an S-Corp structure to pay themselves the necessary wages.

Those who have a job in addition to trading can double their retirement savings by maximizing their employer 401(k) and contributing another $58,000 to an unaffiliated TTS S-Corp Solo 401(k) or profit-sharing plan.

The TTS S-Corp pays officer compensation, which engineers the earned income required for employee benefit tax deductions, including health insurance premiums and retirement plan contributions. Conversely, trading gains from capital gains or Section 475 ordinary income are considered unearned income, for which the IRS does not permit retirement plan contributions.

An individual TTS trader deducts business expenses on Schedule C. However, a sole proprietor TTS trader cannot arrange AGI deductions for health insurance premiums and retirement plan contributions because underlying trading gains are not self-employment income (SEI) or earned income. A sole proprietor of any kind cannot pay himself payroll (salaries). It’s also tricky for a TTS partnership to create SEI since partnership compensation and other expenses reduce it. Whereas S-Corp payments do not reduce SEI, making the S-Corp the structure of choice for TTS traders for arranging employee benefits.

In the examples below, full-time Trader A contributes the $64,500 cap to a Solo 401(k) retirement plan for 2021. Part-time Trader B doubles up on retirement benefits, maximizing an unaffiliated employer 401(k) plan for $19,500 and contributing up to the $58,000 cap in her TTS S-Corp profit-sharing plan. Unfortunately, part-time Trader C is out of luck; his consulting company is affiliated with his TTS S-Corp, so he must include consulting company employees in his retirement plan.

Fulltime Trader A
This person owns a single-member LLC (SMLLC) taxed as an S-Corp, eligible for TTS business expense deductions.

In December 2021, based on sufficient annual profits, a TTS S-Corp can pay maximum-required officer compensation of $154,000 to make the Solo 401(k) retirement plan contribution cap of $58,000 ($64,500 for age 50 or older; 2021 limits). Trader A’s Solo 401(k) plan comprises a $19,500 elective deferral, $6,500 catch-up elective deferral for age 50 or older, and a $38,500 profit-sharing contribution for an overall plan limit of $64,500.

Trader A’s W-2 wage statement deducts the Solo 401(k) elective deferral amount of $26,000 from taxable income (box 1), and the S-Corp deducts the profit-sharing contribution of $38,500 on Form 1120-S. The profit-sharing contribution is 100% deductible, but it represents 25% of wages, translating to $38,500 of officer wages (25% of $154,000). The elective deferral of $26,000 is 100%  deductible, and it looks to gross income. If the 401(k) plan only provided for an elective deferral (no profit-sharing contribution), then Trader A would only need wages (net of required deductions) of $26,000 before contribution on a pre-tax basis to the 401(k) (a higher amount may be necessary for a Roth IRA).

Alternatively, if Trader A did not make an elective deferral, the TTS S-Corp could contribute $58,000 to the Solo 401(k) plan on officer wages of $232,000 ($58,000 is 25% of $232,000).

Higher wages trigger an additional Medicare tax of 2.90% (plus a 0.9% Obamacare Medicare surtax over the ACA income threshold). The Medicare tax of 3.8% on earned income (wages) often replaces the 3.8% Obamacare net investment tax for upper-income traders.

If Trader A is married and the spouse provides employment services to the S-Corp, the spouse can also participate in the S-Corp retirement plan. The same goes for working-age children rendering services negotiated at arm’s length.

There’s also an option for a Roth 401(k) (after-tax) plan for the elective deferral portion only. Suppose you are willing to forgo the upfront tax deduction. In that case, you’ll enjoy permanent tax-free status on contributions and growth within the plan — subject to satisfying certain IRS conditions —  and minimum distributions at age 72 are not required.

Of course, W-2 wages are subject to payroll taxes. For 2021, on the Social Security wage base amount of $142,800, 6.2% of Social Security taxes are paid and deducted by the employer, and 6.2% are withheld from the employee’s paycheck. Thus, in most cases, the taxpayer saves more in income taxes than they owe in payroll taxes while at the same time accumulating Social Security benefits for retirement.

Part-time Trader B working for Big Tech
This trader has a full-time job with a Big Tech company earning a W-2 salary of $300,000 per year. Trader B seeks to maximize participation in her employer’s 401(k) retirement plan, with an elective deferral of $19,500 (under age 50), plus an employer matching contribution of 6%, which does not count towards the elective deferral limit.

Trader B also operates a TTS S-Corp and makes $400,000 in capital gains for 2021. In addition to her employer’s 401(k), Trader B wants to utilize a Solo 401(k) retirement plan to maximize her savings.

The critical issue is whether Trader B’s TTS S-Corp is affiliated with her employer. Assuming it is unaffiliated, Trader B can maximize multiple employer retirement plans, with an essential restriction: An individual can only defer the limit ($19,500 plus $6,500 catch-up, if over 50) regardless of the number of plans. So, Trader B skips the elective deferral in her Solo 401(k) and makes a $58,000 (2021 limit) profit-sharing contribution to her Solo 401(k) plan or contributes to a SEP IRA. Trader B would need $232,000 in wages to maximize the profit-sharing contribution of $58,000 ($232,000 divided by a 25% rate for an S-Corp). Trader B’s TTS S-Corp shows a net profit after deducting officer compensation and the retirement plan contribution. (See Retirement Topics – 401(k) and Profit-Sharing Plan Contribution Limits.)

When a taxpayer receives wages from more than one employer, there might be duplicate Social Security taxes for the employer share if over the Social Security wage base amount. The individual tax return identifies excess employee Social Security taxes and reclassifies them as a federal tax credit, avoiding redundancy on the employee share.

Part-time Trader C with an Affiliated Company
This trader owns 100% of a consulting business S-Corp with 10 full-time employees. The consulting S-Corp does not offer a retirement plan to its employees. Trader C wonders if the TTS S-Corp can establish a Solo 401(k) plan and deny participation by consulting business employees. The answer is no because these two employers are affiliated.

The controlled group non-discrimination rules prevent an owner from discriminating against his employees by excluding them from retirement benefits. It is wise to consult an employee benefits attorney about vesting and other means to work within the constraints of the non-discrimination, controlled group, and affiliated service group rules. 

Q&A with Employee-benefits Attorneys    

I asked the following questions to employee-benefits attorneys Rick Matta, David Levine, and Joanne Jacobson of Groom Law Group.

  1. Do you agree with the retirement plan strategy for full-time Trader A?

    Yes, with the caveat that a TTS trader must have earned income (W-2 wages) for this retirement plan strategy. 

  2. Can Trader B maximize her Big Tech employer’s 401(k) plan while contributing the maximum allowed $58,000 to a TTS S-Corp profit-sharing plan for 2021?

    Yes, as long as the two employers are unaffiliated. Multiple employers can have various retirement plans, but a taxpayer is limited to one 401(k) elective deferral limit.

  3. If Trader B only contributes $10,000 to his Big Tech employer’s 401(k), can he contribute the remaining $9,500 to a TTS S-Corp Solo 401(k)? If yes, is there a formal integration required?

    Yes, the $19,500 / $26,000 limit is based on the individual across all plans in which he or she participates. Therefore, coordination of these limits across plans is required.

  4. Do you agree that Trader C’s consulting S-Corp is affiliated with his TTS S-Corp? How does affiliation restrict Trader C?

    From the facts presented, it appears that they are affiliated, and the IRS non-discrimination rules could limit the amounts Trade C could save for retirement.  However, it is essential to keep in mind that there are many ways that “affiliation” can occur. For example, it can be due to common ownership (commonly called “controlled group”), sharing of services (commonly called “affiliated service group”), or even common governance or control (especially for non-profits). Therefore, a careful review of each structure is vital to avoid potentially costly failures.

  5. Do you recommend that Traders A, B, and C also consider a nondeductible IRA if they are not eligible for deductible IRA contributions?

    Nondeductible IRAs are always on our list to consider when speaking with TTS traders with earned income. 

  6. Do you support converting IRAs and 401(k) rollovers to Roth IRAs?

    These types of IRAs – called “back door Roth IRAs” by some in the industry – are popular planning tools.  While each individual’s tax planning varies, they are often seen as advantageous.  We also note that there are in-plan Roth conversion opportunities in 401(k) plans that can have other benefits that can be worth considering.

  7. Are defined benefit plans appropriate for upper-income TTS traders? Defined benefit plans – when carefully designed – can provide significant tax-advantaged savings vehicles and are almost always worth consideration.

Many of our TTS trader clients operate in an S-Corp, and they select a Solo 401(k) retirement plan and execute the strategy through year-end payroll. Adding a traditional IRA, Roth IRA, or nondeductible IRA contribution by April 15 tax time is generally a good idea, too.

Consider consulting with an employee benefits attorney to discuss multiple employer retirement plans, affiliate service group rules, defined benefit plans, and back door Roth strategies.

Contributions by Adam Manning, CPA, and Groom Law attorneys Rick Matta, David Levine, and Joanne Jacobson.

Unlock State & Local Tax Deductions With A SALT Cap Workaround

June 22, 2021 | By: Robert A. Green, CPA | Read it on

Updates: As states progress on SALT cap workaround legislation, I will update that news at the bottom of this post. 

Since 2018, taxpayers living in high-tax states have been unable to take an itemized deduction of state and local taxes over a limitation (known as the “SALT” cap) of $10,000 per year. This limitation came from the 2017 Tax Cuts and Jobs Act (TCJA) and is effective for tax years 2018 through 2025. But the good news is that some states have a workaround, which I cover in this post.

On Nov. 9, 2020, Treasury and the IRS issued Notice 2020-75, which says they “intend to issue proposed regulations to clarify that State and local income taxes imposed on and paid by a partnership or an S corporation on its income are allowed as a deduction by the partnership or S corporation in computing its non-separately stated taxable income or loss for the taxable year of payment.”

The Workaround
To date, state laws for SALT cap workarounds vary, but the general idea is that a pass-through entity (PTE) assesses a tax at the state’s rate on individuals. The state then grants the respective owners of the PTE a tax credit on their state personal income tax return. The SALT cap only applies to individual taxes, not PTE entity-level taxes. Other states subject the PTE to an entity-level tax and then exclude that respective PTE income from the owner’s state tax return.

Check the latest news in your state to see if your state has enacted a SALT cap workaround when the tax law is effective (i.e., 2021 or 2022) and how it works. For example, Connecticut made the PTE tax mandatory for the SALT cap workaround strategy. Most of the other states make it elective, giving the taxpayer more choices; however, don’t miss the election deadline. Consult your tax advisor to see how this strategy might save you money and whether you should consider forming a pass-through entity soon in 2021.

Traders seem to qualify for the SALT cap workaround
Many traders eligible for trader tax status (TTS) already use a PTE like a spousal-member LLC/partnership or single-member LLC/S-Corp. TTS traders need an S-Corp to pay officer compensation to unlock health insurance and retirement plan deductions, which otherwise are not allowed on trading gains that are unearned income.

A TTS trader in securities, commodities, and other financial products, has business expense treatment. A TTS trader actively buys and sells capital assets with capital gains and losses, or Section 475 ordinary gains and losses, if elected on a timely basis.

Here’s an example: In 2021, Joe Trader pays $35,000 of state income taxes on the S-Corp level using a SALT cap workaround. His S-Corp net income is $500,000, subject to a state tax rate of 7%. Joe reaches his SALT cap of $10,000 with real estate taxes of $11,000, so he loses a $1,000 deduction. Joe deducts $35,000 of the S-Corp state taxes from his gross income saving $12,950 in federal taxes ($35,000 state tax deduction x 37% top marginal federal tax rate). Without a SALT cap workaround, Joe would have $36,000 of non-deductible SALT.

Next steps
Many accountants had taken a wait-and-see approach on SALT cap workaround strategies since IRS approval was uncertain before the November 2020 IRS notice mentioned above. In addition, the IRS and Treasury previously rejected recharacterizing SALT payments as charitable contributions, which a few states attempted.

This PTE tax approach is not foreign; some southeastern states use PTE composite returns to assess tax on non-resident owners. 

Some tax pundits expected the Biden administration to repeal the SALT cap. However, President Biden’s FY 2022 budget and recent infrastructure bills do not include the reversal of the SALT cap. Congressional Republicans are resistant to undermine TCJA. Some Congressional Democrats stated they might not support Biden’s infrastructure bills unless they fix the SALT cap. Stay tuned!

The PTE tax might be a better solution than pre-TCJA law when SALT was an itemized deduction and a preference for alternative minimum tax (AMT).

Updated news by state below

IRS Signals Approval of Entity-Level SALT Cap Workaround, But States Should Still Think Twice (Tax Foundation Nov. 11, 2020)
“Treasury and IRS signaled their intention to bless one type of state workaround for the $10,000 State and Local Tax (SALT) deduction cap: entity-level taxes that allow owners of pass-through businesses to pay an additional state tax at the business level, with an offsetting credit against their individual income tax liability. Since the SALT deduction cap does not apply to business taxes, this functionally allows these owners to avoid the cap, since the entity-level tax substitutes for their income tax payment, which would have been subject to a capped deduction.”

“Connecticut, Louisiana, Maryland, New Jersey, Oklahoma, Rhode Island, and Wisconsin have all adopted entity-level taxes which offer credits against the owners’ personal tax liability. In Connecticut, the entity-level tax is mandatory. In the other six states, it is elective; business owners can choose to pay it and claim the credit, or may decline if it is not in their best interest to go that route.”

New Jersey enacts SALT deduction cap workaround (Grant Thorton Feb. 14, 2020)

California Lawmakers, Governor Float SALT Cap Workaround Plans (Bloomberg Tax Jan. 14, 2021)
“A new California Senate bill (SB 104) would give pass-throughs—partnerships, limited liability companies, and S corporations—the option to pay an entity-level income tax that would be fully deductible. The bill doesn’t specify a tax rate yet. Individuals who are members of those businesses would exclude the amount the entity pays from their gross income.” (Governor) Newsom’s proposal is narrower, applying only to S corporations. It would give those businesses the option to pay a 13.3% income tax rather than the 1.5% that California currently imposes on S corporations. Shareholders would get a tax credit equal to 13.3% of their passed-through income. Under current California law, an S corporation’s income is also taxable at the shareholder level.”
Calif. Gov. Updates Budget With Tax Rebates, SALT Workaround (Law360 May 14, 2021)
California budget deal reached: More stimulus payments and tax relief (Spidell News June 28, 2021)
“The Governor and legislative leaders announced that they have reached a budget deal. Major tax-related items contained in the deal include an elective passthrough entity tax, which provides a work-around to the $10,000 SALT deduction limitation for owners of passthrough entities…These provisions are contained in draft legislation that has not yet been enacted, although it is anticipated that these bills will be passed within the next week or two.” https://leginfo.legislature.ca.gov/
SALT Cap Workaround, Tax Credit Boosts Go To California Governor (Bloomberg Tax July 1, 2021)
“A California workaround to the $10,000 federal cap on state and local tax deductions, expanded tax credits, and new grants for businesses are included in bills lawmakers sent Thursday to Gov. Gavin Newsom (D). Tax policy changes in a bill lawmakers passed Thursday (A.B. 150) include a workaround for the $10,000 cap on state and local tax deductions for S corporations and their shareholders. The corporations could pay 9.3% income tax rather than the 1.5% rate California currently imposes. Shareholders would get a tax credit equal to 9.3% of their passed-through income. The workaround would be in effect for taxable years 2021 through 2025 and taxpayers would have to use the option on original, timely filed tax returns.
Calif. Joins States With SALT Cap Workaround (Law360 July 16, 2021)
“Gov. Gavin Newsom, a Democrat, signed A.B. 150… he reiterated his position that the cap on the SALT deduction should be lifted but said California would provide “a partial fix” for S corporations and other pass-throughs. California’s SALT workaround for pass-through entities will be an elective tax that the entity pays on behalf of partners. The partners can then receive a credit. The tax rate will be 9.3% and will fall on the distributive shares of income of the partners. Individual partners can choose not to consent, but the entity can still elect to pay the tax. Those partners who do consent will get a nonrefundable credit that equals the amount of tax paid by the entity on the partners’ behalf. The pass-through workaround will begin for tax year 2021 and sunset after tax year 2025, according to the analysis.”
SALT workaround elective passthrough entity tax (Spidell’s California Minute July 18, 2021)

New York Includes SALT Cap Workaround in Budget Deal (Bloomberg April 6, 2021)
“The deal between New York Gov. Andrew Cuomo (D) and Democratic legislative leaders, announced Tuesday, would allow pass-through businesses to pay taxes at the entity level. The entity-level tax would be offset by a corresponding individual income tax credit.”
New York Governor Signs Bill That Could Provide Pass-Through Entities a SALT Deduction Cap Workaround (NYSSCPA April 10, 2021)
New York State Budget Provides A Work Around To The Federal SALT Cap For Certain Business Entities (Forbes May 27, 2021)

Alabama Lawmakers Advance Changes to SALT Cap Workaround (Tax Notes April 15, 2021)

La. Senate Approves SALT Cap Workaround For Pass-Throughs (Law360 May 23, 2021)

SALT Workarounds Spread to More States as Democrats Seek Repeal (Bloomberg Tax April 27, 2021)
“Seven states, including California and Illinois, are poised to join nearly a dozen others like New York and New Jersey that have skirted around the federal cap on state and local tax deductions as the prospect of a federal fix remains elusive. New York and Idaho both recently passed legislation to work around the controversial 2017 tax law feature known as the SALT cap. Georgia and Arizona are awaiting their governors’ approvals of similar SALT cap workarounds, and lawmakers in California, Massachusetts, Illinois, North Carolina, and South Carolina are debating bills of the same nature.” (See the state map of states included in the workaround.)

Massachusetts Lawmakers Push SALT Cap Workaround in Budget (Bloomberg Tax May 11, 2021)
Mass. Senate OKs Budget With Child Credit, SALT Workaround (Law360 June 2, 2021)
“The pass-through provision is similar to other entity-level taxes that states have either enacted or are considering as a workaround to the $10,000 state and local tax deduction cap. The pass-through entity-level tax provisions would take effect for taxable years beginning on and after Jan. 1, 2021.”
Mass. Legislators Pass Budget With SALT Workaround, Credits (Law360 July 9, 2021)
“The Massachusetts Legislature unanimously passed a fiscal year 2022 budget Friday that would establish an entity-level tax for pass-through businesses…would allow an entity-level tax on pass-throughs and provide a credit against a member’s share of that tax.”
Mass. Gov.’s Budget Creates Tax Credits, Vetoes Deduction Delay (Law360 July 19, 2021)
“Republican Gov. Charlie Baker on Friday signed the budget bill while returning to the Legislature a provision that would allow an entity-level tax on pass-throughs and provide a credit against a member’s share of that tax, asking it to increase the credit portion. Baker returned the pass-through provision to the state Legislature with proposed amendments that would increase a member’s credit from 90% of their share in the entity’s tax to 100% of their tax share, saying that taxpayers should collect the full benefit as struggling businesses emerge from the pandemic. The pass-through entity-level tax provisions will take effect for taxable years beginning on and after Jan. 1, 2021.”
Massachusetts Lawmakers Override Governor on SALT Cap Fix (1) (Bloomberg Tax July 29, 2021)
“Both the governor and lawmakers agreed to a SALT cap fix that would allow individuals to get around the $10,000 deduction limit by having pass-through entities they are members of, like S corporations, pay the 5% state excise tax, instead of having income flow to individual members for taxation. The lawmakers’ measure, however, would allow the individual members a credit equal to the share of state taxes owed, multiplied by 0.9. This would bring in $90 million annually to the state, they estimate. Baker had wanted a 100% credit for individual members.” 
Capital gains and Section 475 ordinary income is taxed at the 12% rate. 

SC Offers SALT Cap Workaround Through Entity-Level Tax (Law360 May 19, 2021)
“Republican Gov. Henry McMaster signed S.B. 627 on Monday, allowing partnerships and S corporations to make an annual election to pay a 3% tax at the entity level while offering a corresponding income exclusion for owners and partners. The bill will take effect starting in tax year 2021.”

Illinois Assembly Approves SALT Workarounds for Partnerships (Bloomberg Tax May 31, 2021)

SALT Workaround for Pass-Throughs Advances to Michigan Governor (Bloomberg Tax June 23, 2021)
“The SALT cap workaround bill (H.B. 4288) could provide roughly $190 million in federal tax relief for Michigan businesses without costing the state a dime, according to a legislative fiscal statement. The measure would let pass-through businesses pay state and local taxes at the entity level starting in tax year 2021, allowing the full deduction of these taxes on federal returns instead of limiting the deduction amount the entity owners can currently claim on their flow-through income.”
Mich. Gov. Vetoes SALT Deduction Cap Workaround Bill (Law360, July 14, 2021).
Michigan’s governor vetoed a bill seeking to create an entity-level tax for pass-through businesses to sidestep the federal cap on state and local tax deductions, saying the bill’s $5 million cost to implement should be part of broader budget negotiations.

Democrats consider ‘SALT’ relief for state and local tax deductions (NBC News June 24, 2021)

Georgia Enacts Salt Cap Workaround For Tax Years Starting In 2022 (Windham Brannon)
House Bill 149, which was signed into law, creates a SALT cap workaround for Georgia partnerships and subchapter S corporations.”

Maryland’s SALT Workaround: Impacts and Planning Opportunities (March 12, 2021)

Rhode Island Budgets For Salt Workaround (Aug. 2019)

Wisconsin enacts SALT deduction workaround with pass-through tax (Dec. 17, 2018)

IRS Provides Clarity Regarding Oklahoma’s Salt Cap Workaround (March 3, 2021)

North Carolina Republicans Introduce SALT Cap Workaround (Tax Notes April 8, 2021)

Ore. Senate OKs Trimming Biz Tax Break, SALT Workaround (Law360, June 17, 2021)
“Under S.B. 727, the state would create an elective entity-level tax on qualifying pass-through entities. The tax rate would be 9% for the first $250,000 of income and 9.9% for income above $250,000. If an entity elects to pay the tax, the owners would be allowed an offsetting tax credit to claim on their personal income tax returns.”

Colo. Limits Tax Breaks, OKs SALT Workaround In Tax Overhaul (Law360, June 24, 2021)
Gov. signed “H.B. 1327 provides for the entity-level tax to circumvent the $10,000 SALT cap.”
Colo. Lawmakers OK Entity-Level Taxation To Skirt SALT Cap (Law360, June 9, 2021)
“Under the bill, the state would allow pass-through entities to elect to pay an entity-level tax for income tax years beginning on or after Jan. 1, 2022. The entity-level tax rate would be 4.55%, the same as the state’s flat income tax rate.”

Pa. Bill Seeks Entity-Level Tax To Bypass SALT Deduction Cap (Law360 June 29, 2021)
“H.B. 1709, introduced Monday by Rep. Martina A. White, R-Philadelphia, would allow partnerships and S corporations to elect to be taxed at the entity level while providing an offsetting credit to owners and shareholders.”

Arizona House Panel OKs Entity-Level Tax To Skirt SALT Cap (Law360 Feb. 18, 2021)
Ariz. Adopts High-Earner Tax Bypass, SALT Cap Workaround  (Law360 July 12, 2021)
“Arizona will create an alternative business income tax and an entity-level tax, bypassing both a state income tax surcharge on high earners and the federal cap on state and local tax deductions under two bills signed by the governor. H.B. 2838 will allow partnerships and S corporations to elect to pay a 4.5% tax at the entity level and offer a credit to the entity’s partners, members or shareholders for their pro rata share of the tax, according to a bill analysis. The entity-level tax election will be available only if all of an entity’s members, partners or shareholders are Arizona residents. The bill will take effect on Jan. 1, 2022, and the credit is allowed to be carried forward for up to five consecutive years.”

A Closer Look at Minnesota’s Proposed SALT Cap Workaround (Minnesota Center for Fiscal Excellence)
Minn. To Offer SALT Cap Workaround, PPP Loan Tax Relief (Law360 July 1, 2021)
“Democratic Gov. Tim Walz signed into law H.B. 9. The law creates an entity-level tax for pass-through entities with a refundable credit for entity members, allowing them to bypass the $10,000 state and local tax cap.”

Ark. Bill Floats SALT Cap Workaround With Pass-Through Tax (Law360 Jan. 20, 2021)

Darren L. Neuschwander, CPA, contributed to this blog post. 

 

 

 

 

 

 

 

 

 

 

 

 

 

The American Rescue Plan Act of 2021 Impacts Traders

June 21, 2021 | By: Robert A. Green, CPA

On March 11, 2021, Congress and President Biden enacted “The American Rescue Plan Act of 2021” (ARP). In this post, I focus on the provisions that could impact traders, including recovery rebates for individuals, EBL extension, child tax credit, loan forgiveness, and more. The quotations included under each topic are from the “American Rescue Plan Act Roadmap” published by Bloomberg Tax & Accounting.

Many of the ARP tax benefits are subject to income thresholds. Traders have widely fluctuating income and losses from year to year, and they might qualify for some of these tax benefits. ARP includes business and health care benefits, but most don’t apply to solo TTS traders.

2021 Recovery Rebates to Individuals

“Provides a $1,400 refundable tax credit to individuals ($2,800 for joint filers) with up to $75,000 in adjusted gross income (or $112,500 for heads of household and $150,000 for married couples filing jointly). Provides $1,400 for dependents (both child and non-child). The credit will be phased out entirely for those with incomes above $80,000 (or $120,000 for heads of household and $160,000 for married couples filing jointly). The credit is reduced between $75,000 and $80,000 (or $112,500 and $120,000 for heads of household and $150,000 and $160,000 for married couples filing jointly).”

Extension of Limitation on Excess Business Losses (EBL)

A trader eligible for trader tax status (TTS) using a Section 475 election for ordinary loss treatment might exceed the EBL threshold. The excess is a net operating loss (NOL) carry forward. The original 2018 EBL threshold was $500,000/$250,000 married/other taxpayers, and it’s adjusted for inflation.

“Extends for an additional year (through 2026) the denial of a current-year deduction for business losses of a noncorporate taxpayer to the extent they exceed business income plus a threshold amount.”

Suspension of Income Tax on Portion of Unemployment Compensation

Many traders collected unemployment compensation in 2020, as they lost their jobs during the Covid pandemic. Some commenced a TTS trading activity after the Covid crash in March 2020; it’s important to note trading gains do not conflict with unemployment insurance benefits. A TTS S-Corp with officer compensation, however, does conflict with unemployment benefits.

“For 2020, excludes from gross income up to $10,200 of unemployment compensation received for individuals with adjusted gross income of less than $150,000.”

Child Tax Credit

“Increases the child tax credit amount for 2021 only, to $3,600 for children under 6, and to $3,000 for children ages 6 to 17; expands definition of ‘qualifying child’ to include 17-year-olds.”

Credits for Paid Sick and Family Leave for Certain Self-Employed Individuals

“Extends the refundable paid sick time and paid family leave credits established by the Families First Coronavirus Response Act through September 30, 2021. For purposes of the family leave credit, between April 1, 2021, and September 30, 2021, eligible wages are increased to $12,000 from $10,000. Extends eligibility to additional self-employed workers.”

Student Loan Forgiveness

“For eligible student loans discharged in 2021-2025, the discharged amounts are excluded from income. The exclusion from income does not apply to the discharge of a loan made by certain lenders if the discharge is on account of services performed for the lender.”

Links

FACT SHEET: The American Rescue Plan Will Deliver Immediate Economic Relief to Families (U.S. Department of the Treasury, March 18, 2021)

The American Rescue Plan (Whitehouse.Gov). Consumer-friendly approach. 

Tax provisions in the American Rescue Plan Act (Journal of Accountancy, Feb. 27, 2021)

 

The IRS postponed the 2020 individual tax deadline to May 17

April 6, 2021 | By: Robert A. Green, CPA

The IRS postponed the 2020 individual tax filing and payment deadline to May 17, 2021, including the 2021 Section 475 election. For Texas, Oklahoma, and Louisiana residents, the deadlines are June 15, 2021. 

April 13, 2021: The IRS continues to assert that 2021 first quarter estimated tax payments are due April 15, even though they postponed the 2020 individual tax filing and payment deadline to May 17, 2021. See IRS notice Electing To Apply a 2020 Return Overpayment From a May 17 Payment with Extension Request to 2021 Estimated Taxes

March 29, 2021: The good news is the individual Section 475 election is due May 17, 2021, with the 2020 tax return or extension. The IRS issued formal guidance Notice 2021-21, “Relief For Form 1040 Filers Affected By Ongoing Coronavirus Disease 2019 Pandemic.” The IRS notice states, “Finally, elections that are made or required to be made on a timely filed Form 1040 series (or attachment to such form) will be timely made if filed on such form or attachment, as appropriate, on or before May 17, 2021.” The IRS notice also postponed the 2020 IRA and HSA contribution tax deadline to May 17, 2021.

March 17, 2021: Tax Day for individuals extended to May 17: Treasury, IRS extend filing and payment deadline. “The Treasury Department and Internal Revenue Service announced today that the federal income tax filing due date for individuals for the 2020 tax year will be automatically extended from April 15, 2021, to May 17, 2021. The IRS will be providing formal guidance in the coming days. Individual taxpayers can also postpone federal income tax payments for the 2020 tax year due on April 15, 2021, to May 17, 2021, without penalties and interest, regardless of the amount owed. This relief does not apply to (2021) estimated tax payments that are due on April 15, 2021. The IRS urges taxpayers to check with their state tax agencies for those details.” (IRS Issue Number: IR-2021-59). Intuit: State Tax Deadline Updates. The postponement does not apply to C-Corps, trusts, and estates.

Feb. 22, 2021: For residents of Texas, Oklahoma, and Louisiana, the IRS postponed the April 15, 2021 tax filing and payment deadline until June 15, 2021, after a federal disaster declaration in February 2021 due to winter storms. It also extended the 2021 Q1 estimated income tax payment deadline from April 15 to June 15, 2021. The delay includes various 2020 business returns due on March 15, including partnerships and S-Corps. The postponement also applies to the 2021 Section 475 election for individuals and pass-through entities in these three states.

Emergency $900 Billion Pandemic Relief

January 10, 2021 | By: Robert A. Green, CPA

On Dec. 21, 2020, Congress passed an emergency $900 billion pandemic relief bill, extending CARES to people in need. On Dec. 27, 2020, the President signed the legislation, part of a government funding package. The new Covid-19 legislation includes:

Direct payments: The maximum amount is $600 for individuals and $1,200 for married couples filing jointly, plus an additional $600 per qualifying child. Subject to phase out for individuals making more than $75,000 modified adjusted gross income and married couples over $150,000. It’s a 2020 advanced recovery rebate with eligibility based on 2019 tax returns. These direct payments are non-taxable income.

Extension of federal pandemic unemployment compensation: Restores FPUC supplement to all state and federal unemployment benefits at $300 per week, starting after Dec. 26, 2020, and ending March 14, 2021. These unemployment benefits are taxable income.

Small business PPP forgivable loans: The new legislation clarifies tax treatment under the CARES Act. Borrowers may deduct PPP business expenses financed with PPP loans, and loan forgiveness is not taxable income. New funding allows “PPP second-draw” loans for smaller and harder-hit businesses, with a maximum of $2 million.

Business meals tax deduction raised to 100% through 2022, increased from 50%. Traders don’t have many business meals.

TTS traders might qualify for direct payments but not unemployment benefits since they don’t have earned income from trading. The SBA labels trading a speculative business precluding it from SBA loans, including PPP loans.

Full details have yet to be released, so stay tuned to our blog to see how this impacts TTS traders.

See the CARES Act in our Tax Center.

How Traders Improve Tax Savings With Year-End Strategies

November 11, 2020 | By: Robert A. Green, CPA | Read it on

Tax Planning

Year-end tax planning for traders varies based on eligibility for trader tax status (TTS) in 2020 and 2021. There are different strategies to consider for investors, TTS traders using the capital gains method, and TTS traders using Section 475 MTM ordinary gain and loss treatment.

In this blog post, I examine all three groups and touch on the topics of new traders, S-Corps for employee benefits, Roth IRA conversions, and navigating the SALT cap.

Investors
The 2017 Tax Cuts And Jobs Act (TCJA) suspended investment fees and expenses for investors, and the 2020 Coronavirus Aid, Relief, and Economic Security (CARES) Act did not change that. After TCJA, the only itemized deductions for investors are margin interest expense limited to investment income and stock-borrow fees. TCJA roughly doubled the standard deduction: with an inflation adjustment for 2020, it’s $24,800 married, $12,400 single, and $18,650 head of household. TCJA’s $10,000 cap on state and local taxes (SALT) leads many taxpayers to use the standard deduction.

TTS traders are better off; they deduct trading business expenses, startup costs, and home office expenses from gross income (Schedule C for sole proprietors). Brokerage commissions are transaction costs deducted from trading gains or losses; they are not separate expenses.

In 2020 with Covid-19 stay-at-home orders and remote work, many new traders entered the markets. Some achieved TTS for a partial year in 2020, whereas others won’t qualify until 2021. If your TTS commences in January 2021, you can capitalize on some hardware, software, and other intangible costs incurred in 2020 for depreciation and amortization expense with TTS’s commencement in early 2021. For example, computers, monitors, and home office furniture contribute to these costs at fair market value for TTS expensing in 2021. Some expenses like subscriptions, education, and software can be capitalized as Section 195 startup costs. Section 195 allows expensing up to $5,000 in 2021, with the rest deducted straight-line over 15 years. We allow TTS traders to go back six months before TTS inception for Section 195 costs and even further back for hardware costs.

Investors and TTS traders using the default realization method (not Section 475 MTM) should consider “tax-loss selling” before year-end to reduce capital gains income and the related tax liability. However, be careful to avoid wash-sale loss adjustments on securities at year-end 2020, which defer the tax loss to 2021. For example, suppose you realize a capital loss on Dec. 15, 2020, in Exxon and repurchase a substantially identical position (Exxon stock or option) 30 days before or after that date. In that case, it’s a wash-sale (WS) loss adjustment. The WS loss defers to 2021 when it is added to the replacement position’s cost basis. The rules are different for brokers vs. taxpayers, so avoid permanent WS between taxable and IRA accounts. Section 1256 contracts have MTM by default, so WS is a moot point on futures. (See more on WS on our website.)

If you expect a net capital loss for 2020 over the $3,000 capital loss limitation against other income, then you’ll have a capital loss carryover (CLCO) to 2021 and subsequent years. You can use up a CLCO with capital gains in the following years. For example, if your CLCO is $25,000 going into 2021, and you have 2021 capital gains of $30,000, then you’ll have $5,000 of net capital gains for 2021.

If you incur a significant capital loss in Section 1256 contracts, consider a 1256 loss carryback election made on Form 6781 filed with your 2020 tax return. That allows you to amend the prior three-year tax returns to apply the 1256 loss against 1256 gains only.

If your 2020 taxable income is considerably under the capital gains tax bracket of $80,000 for married and $40,000 for unmarried individuals, then your long-term capital gains (LTCG) tax rate is 0%. For example, assume your taxable married-filing-joint income is $50,000 as of late December 2020. You can sell investments held over 12 months with up to $30,000 of capital gains at a 0% tax rate. Don’t cut it too close, though: If your taxable income is $80,500, it will trigger the 15% rate on all LTCG. The 0% rate applies to Section 1256 contracts: 60% uses the LTCG rate, and 40% the short-term rate, which is the ordinary rate.

There is also the Affordable Care Act (ACA) 3.8% net investment tax (NIT) on net investment income (NII) for upper-income taxpayers with modified AGI above $250,000 married and $200,000 single. Tax-loss selling and other deductions lower AGI and NII, which can help avoid or reduce NIT.

President-elect Joe Biden’s Tax Plan proposed raising the top LTCG rate of 20% to a maximum ordinary rate of 39.6% (up from 37%), applying only to taxpayers with income over $1 million. Passing Biden’s tax plan will be difficult if the Senate remains under Republican control.

There may be further Covid-19 aid and tax relief bills enacted during the lame-duck session, impacting year-end tax planning. (See How Covid-19 Tax Relief & Aid Legislation Impacts Traders.)

Traders who have massive trading gains in 2020 should focus on 2020 Q4 estimated taxes due Jan. 15, 2021. Using the safe-harbor exception to cover 2019 tax liabilities, some traders can defer much of their tax payments to April 15, 2021. Just don’t lose the tax money in the markets in Q1 2021; consider setting it aside. (See Traders Should Focus On Q4 Estimated Taxes Due January 15.)

Traders eligible for TTS
If a trader qualifies for TTS in 2020, he or she can deduct trading business expenses, startup costs, and home-office expenses. The trader did not have to elect TTS or create an entity. (Section 475 requires a timely election.) It’s okay to commence TTS during the year, although we prefer not later than Sept. 30; otherwise, the IRS could challenge TTS for Q4 or less. (See How To Be Eligible For Substantial Tax Savings As A Trader.)

TTS traders planning to upgrade computers and other expenses should consider accelerating business expenses before year-end. New equipment and furniture need be purchased and put to use before year-end. TCJA mostly provides full expensing with tangible property expense up to $2,500 per item, Section 179 (100%) depreciation, or bonus depreciation.

TTS traders with Section 475 MTM
TTS traders using section 475 mark-to-market (MTM) accounting report ordinary gains or losses on Form 4797. Section 475 trades are not subject to WS or a capital-loss limitation so that an ordinary loss can offset income of any kind. MTM reports unrealized gains and losses at year-end, so the taxpayer doesn’t have to do tax-loss selling on TTS trading positions.

Many TTS traders also have segregated investment positions, so they should consider WS and tax-loss selling on investment positions. Investments are not subject to Section 475, meaning you can defer capital gains and achieve the LTCG rate on investment positions if held 12 months. If you trade in substantially identical positions that you also invest in, the IRS can attempt to recharacterize TTS trades vs. investments. Avoid that issue by considering a TTS LLC/partnership or TTS LLC/S-Corp for 2021 to ring-fence trading positions.

If you have significant Section 475 ordinary losses for 2020, the CARES Act provides substantial relief. The CARES Act allows a five-year net operating loss (NOL) carryback applied against income of any kind. CARES also temporarily reversed TCJA’s “excess business loss” (EBL) limitation of $500,000 married and $250,000 for other taxpayers (2018 limits and adjusted each year for inflation). Under TCJA, you have to add EBL amounts to NOL carryforwards.

For example, a TTS/475 trader filing single with a $300,000 ordinary loss and $25,000 TTS expenses would have a 2020 NOL of approximately $325,000. The $250,000 EBL limitation does not apply. This trader can carry back the 2020 NOL five years and use it against any type of income. Alternatively, if preferred, the taxpayer can elect to carry it forward instead. TCJA NOL rules apply again in 2021, limiting NOLs to 80% of taxable income with the remainder carried over to subsequent years. Under its latest Covid-19 relief bills, the House proposed revising the NOL and EBL rules, reapplying EBL to all years, and limiting the number of NOL carryback years. Many taxpayers already filed NOL carryback returns under CARES, so it’s hard to reverse those rules now.

If a TTS trader has significant TTS/475 income, they might be eligible for a 20% “qualified business income” (QBI) deduction. Sole proprietors only get this QBI deduction if they are under the QBI taxable income threshold of $326,600 married and $163,300 for other taxpayers (2020 threshold adjusted for inflation). Determine the QBI deduction on the lower of taxable income or QBI. Suppose you have a TTS S-Corp with officer compensation. In that case, there is also a phase-out/phase-in range based on wages and qualified property for an additional $100,000 married and $50,000 other taxpayers.

New traders
No matter when you started trading, you can claim TTS eligibility and add a Schedule C for the TTS expense deductions for all or part of the year. (See Will The IRS Deny Tax Benefits To Traders Due To Covid?)

It’s now too late in 2020 to form a new entity that can qualify for TTS, as we like to see entity trading for at least all of Q4. Instead, consider a Section 475 election for 2021, due by April 15, 2021, for individuals and March 15, 2021, for existing partnerships and S-Corps. (See Traders Elect 475 For Enormous Tax Savings.)

S-Corps for employee benefits
A TTS S-Corp can unlock officer health insurance (HI) and retirement plan deductions using officer payroll. The insurance premium can be added to officer payroll on the W-2. That opens an AGI deduction for HI on the officer’s tax return. The officer HI compensation is not subject to payroll tax (social security and Medicare).

If profitable as of early December 2020, the S-Corp can pay additional compensation up to a maximum of $150,000 to maximize a Solo 401(k) retirement plan contribution. For 2020, it combines a 100% deductible “elective deferral” (ED) contribution of $19,500 with a 25% deductible profit-sharing plan contribution (PSP) up to a maximum of $37,500. There is also an ED “catch-up provision” of $6,500 for 2020 for taxpayers age 50 and over. Together, the maximum 2020 tax-deductible contribution is $57,000, and when including the catch-up provision, it’s $63,500. The ED portion can be a Roth, so there would be no tax deduction but permanent tax-free status. The PSP must be traditional, though.

Payroll tax includes 12.4% social security taxes but not exceeding the social security base amount of $137,700 for 2020. Medicare tax of 2.9% is unlimited without a base. The employer and employee each pay half the payroll taxes, and the employer deducts its 50% share.

Joe Biden’s tax Plan proposes to subject earned income over $400,000 to payroll taxes. Social security taxes (FICA) only apply to the SSA base amount of $137,700 for 2020 and $142,800 for 2021. Biden’s plan creates a donut hole, but it should not affect traders since they only need $150,000 of wages to maximize a Solo 401(k) retirement plan. A TTS S Corp is not subject to IRS “reasonable compensation” rules as its underlying income is unearned.

An S-Corp accountable reimbursement plan can be used to pay the officer shareholder for home-office and other employee expenses. The IRS requires reimbursement before the year-end 2020.

Partners in LLCs taxed as partnerships can deduct “unreimbursed partnership expenses” (UPE). That is how they usually deduct home office expenses. UPE is more convenient than using an S-Corp accountable plan because the partner can arrange the UPE after year-end.

Roth IRA conversions
You may wish to convert a traditional IRA into a Roth IRA before the year-end. The conversion income is taxable in 2020. Avoid the 10% excise tax on early withdrawals before age 59 1⁄2 by paying the Roth conversion taxes outside the Roth plan. TCJA repealed the recharacterization option, so you can no longer reverse the conversion if the plan assets decline. Roth IRA conversions have no income limit, unlike regular Roth IRA contributions.

Navigating around the SALT cap
According to Bloomberg Law’s SALT Cap Workarounds May Catch On in More States After IRS OK (Nov. 10, 2020):

“More states are expected to pass laws letting businesses avoid the limit on personal tax deductions for state and local taxes, following IRS guidance approving the workaround. Already, states including New Jersey and Connecticut softened the blow of the $10,000 SALT cap with provisions for pass-through businesses like partnerships and S corporations, which are taxed normally at the owner level. The IRS said Monday in a notice that forthcoming proposed rules will allow the states’ workaround, which involves an entity-level tax that is offset by a corresponding individual income tax credit.

“The agency in 2019 killed off (T.D. 9864) a different workaround some states tried, which would have allowed state tax credits for donations made to charitable funds.”

More states might enact this workaround before the year-end 2020. Before you pay Q4 2020 estimated taxes due by Jan. 15, 2021, see if your state allows or requires your partnership or S-Corp to pay taxes for your benefit. Connecticut’s workaround law is mandatory.

For more year-end tax planning strategies, see Green’s 2020 Trader Tax Guide and stay tuned for blog updates.

Consider our 2020 tax compliance service, which includes year-end tax planning and 2020 tax return preparation. We accept new clients for our tax compliance service, providing you are a retail trader, a proprietary trader, or an investment manager. Most of our trader clients are eligible for trader tax status (TTS) benefits. We are pleased to invite traders who fall short of TTS in 2020 to use our 2020 tax compliance service. Perhaps, you will qualify for TTS in 2021 and need a 475 election then, too. By email, please request a new client evaluation (NCE).

Darren Neuschwander, CPA contributed to this blog post.

Traders Should Focus On Q4 Estimated Taxes Due Jan. 15

September 25, 2020 | By: Robert A. Green, CPA | Read it on

Many traders have substantial trading gains for 2020 YTD, and they might owe 2020 estimated taxes paid to the IRS quarterly. Unlike wages, taxes aren’t withheld from trading gains. Others can wait on tax payments until April 15, 2021, when they file their 2020 tax return or extension.

The first two-quarters of estimated tax payments were due July 15, 2020 (the postponed date due to Covid), Q3 was due on Sept. 15, 2020, and Q4 is due on Jan. 15, 2021. Many new traders didn’t submit estimated payments for the first three quarters, waiting to see what Q4 brings. With full transparency at year-end, traders can make Q4 payments with more clarity. Some traders view estimated taxes similar to a margin loan with interest rates of 5% for Q1 and Q2, and 3% for Q3.

The safe-harbor rule for paying estimated taxes says there’s no penalty for underpayment if the payment equals 90% of the current-year tax bill or 100% of the previous year’s amount (whichever is lower). If your prior-year adjusted gross income (AGI) exceeded $150,000 or $75,000 if married filing separately, then the safe-harbor rate rises to 110%. 

Suppose your 2019 tax liability was $40,000, and AGI was over $150,000. Assume 2020 taxes will be approximately $100,000, and you haven’t paid estimates going into Q4. Using the safe-harbor rule, you can spread out the payment, submitting $44,000 (110% of $40,000) with a Q4 voucher on Jan. 15, 2021, and paying the balance of $56,000 by April 15, 2021. This is an excellent option to consider instead of sending $90,000 in Q4 (90% of $100,000). Consider setting aside that tax money due April 15 rather than risking it in the financial markets in Q1 2021. I’ve seen some traders lose their tax money owed and get into trouble with the IRS. 

In the above example, the trader should calculate the underpayment of estimated tax penalties for Q1, Q2, and Q3 on the 2020 Form 2210. Consider using Form 2210’s Annualized Income Installment Method (page 4) if the trader generated most of his trading income later in the year. The default method on 2210 allocates the annual income to each quarter, respectively.

If your 2019 income tax liability is significantly higher than your 2020 tax liability, consider covering 90% of the current year’s taxes with estimated taxes. Check your state’s estimated tax rules, too.

Learn more about estimated taxes at https://www.irs.gov/businesses/small-businesses-self-employed/estimated-taxes.

Employees have another way to avoid underpayment of estimated tax penalties on non-wage income. They can ask employers to increase their wage tax withholding in November and December, which the IRS treats as equally made throughout the year.

Darren Neuschwander CPA contributed to this blog post.

Will The IRS Deny Tax Benefits To Traders Due To Covid?

September 14, 2020 | By: Robert A. Green, CPA | Read it on

So far, 2020 has been a highly volatile year in the financial markets due to significant uncertainty over Covid-19, a shock to the economy, and job losses. As the virus spread in the U.S, millions of displaced Americans turned to trading in financial markets as a means of making a new living. Some became active enough to qualify for trader tax status (TTS) benefits, which requires regular, frequent, and continuous trading. However, will the IRS deny TTS to Covid-19 traders if they only carry on a trading business during the pandemic for a short time?

I’m not as worried about existing traders from 2019 who incurred massive trading losses in Q1 2020 during the Covid correction and stopped trading at that time. Hopefully, they made a Section 475 ordinary loss election due by the July 15, 2020 deadline, which is conditional on eligibility for TTS. These pre-Covid traders were in business for more than 15 months, so their TTS/475 ordinary loss deduction should be safe.

I am more concerned with the millions of newcomer traders who opened online trading accounts offering free or low commissions in 2020. Many rookies have significant trading gains year-to-date, even after the recent sell-off. In the trading business, gains can turn into losses with a substantial correction. When that happens, TTS traders count on Section 475 for tax-loss or fire-loss insurance: The trading house burns down, and you can file for a refund with the IRS. The CARES Act permits five-year net operating loss (NOL) carryback refund claims for 2020, 2019, and 2018 tax returns.

Some rookie traders start off meeting the IRS requirements for TTS. Those rules are vague, so see GreenTraderTax’s golden rules for TTS. I wonder how IRS agents will consider the Covid pandemic when assessing TTS. Consider a furloughed worker who started trading at home full time in mid-2020. Was the trader’s intention to create a new business for the long-term, or to buy time and make some extra money before returning to his or her career after the pandemic subsides? TTS requires the intention to run a business from catching daily market movements, not from making investments for appreciation.

If a new trader started trading on June 1, 2020, but stops or significantly slows down trading when returning to work in November 2020, will the IRS deny TTS because he only traded actively for five months? The IRS agent might cite the landmark tax court case Chen vs. Commissioner, where TTS was denied. Chen only carried on TTS for three months.

I analyzed the Chen case in my trader tax guide; here’s an excerpt. 

Chen vs. Commissioner

Comments from a senior IRS official about the Chen tax court case point out the IRS doesn’t respect individual traders who are brand new to trading activity and who enter and exit it too quickly. Chen only traded for three months before losing his trading money, thereby leaving his trading activity. Chen kept his software engineering job during his three months of trading.

The Chen case indicates the IRS wants to see a more extended time to establish TTS. Some IRS agents like to intimidate taxpayers with a full year requirement, but the law does not require that. Hundreds of thousands of businesses start and fail within three months, and the IRS doesn’t challenge them on business status. The IRS is rightfully more skeptical of traders vs. investors, perhaps even more so during the pandemic. The longer a trader can continue his business trading activity, the better his chances are with the IRS. We often ask clients about their trading activities in the prior and subsequent years as we prepare their tax returns for the year that just ended. Vigorous subsequent-year trading activities and gains add credibility to the tax return being filed. We mention these points in tax return footnotes, too. Traders can start their trading business in Q4 and continue it into the subsequent year.

Chen messed up many things in this case. First and foremost, he lied to the IRS about electing Section 475 MTM ordinary loss treatment on time and then used 475 MTM when he wasn’t eligible. Chen should have been subject to a $3,000 capital loss limitation rather than deducting a massive 475 ordinary loss triggering a huge tax refund. Second, he brought a losing case to tax court and made the mistake of representing himself. Once Chen was busted on the phony MTM election, he caved in on all points, including TTS. Chen did not have many TTS business expenses, so he figured it wasn’t worth continuing to fight.

Even though he only traded for three months while keeping his full-time job, it doesn’t mean he didn’t start a new business — intending to change careers to business trading — and make a substantial investment of time, money, and activity. Tax code or case law doesn’t state that a business must be carried on for a full year or as the primary means of making a living. Countless companies startup and fail in a few short months, and many times the entrepreneur hasn’t left his or her job while experimenting as a businessperson. Chen may have won TTS had he been upfront with the IRS and engaged a tax attorney or trader tax expert to represent him in court.

TTS tax benefits

  1. TTS traders deduct business expenses, startup costs, and home office expenses. Without TTS, investors may only deduct margin interest expense to the extent they have investment income as an itemized deduction. Many use the standard deduction instead.
  2. TTS traders are entitled to elect the robust Section 475 mark-to-market accounting, which converts capital gains and losses into ordinary gains and losses. Short-term capital gains on securities are ordinary income; whereas, 475 ordinary business losses generate tax refunds much faster than a $3,000 capital loss limitation. Section 475 also exempts securities trades from onerous wash sale loss rules, a headache for active traders, which causes phantom income and potentially excess tax liability. The 20% qualified business income (QBI) deduction applies to 475 net income if the taxpayer is under a taxable income threshold. QBI excludes capital gains. Individuals had to elect 475 for 2020 by the postponed deadline of July 15, 2020. A new LLC partnership or S-Corp can select 475 within 75 days of inception.
  3. With a TTS S-Corp, traders can deduct health insurance and retirement plan contributions.

I consult new traders on TTS. It’s incredible how many of these traders, from all walks of life, ages and careers, have made small fortunes since April. Others incurred substantial losses. During my tax consultations, many clients tell me they don’t want to return to their jobs if and when called back, and that TTS trading is their new career, which they cherish.

In The Tax Moves Day Traders Need to Make Now, Laura Saunders and Mischa Frankl-Duval report on this very issue (Wall Street Journal, Sept. 11, 2020), warning taxpayers to be careful when thinking about claiming TTS.

Our own Darren Neuschwander, CPA, was interviewed for the piece, stating he has seen a rise in inquiries about trader tax status this year. “The requirements for this break haven’t been clarified by the IRS, but they are stiff. Among other things, traders often need to trade for at least four hours a day, for an average of four days a week, and make at least 720 trades a year,” Neuschwander said.

Also, see my interview in theWall Street Journal’s July 5, 2020 article, The Benefits of Calling Yourself a ‘Trader’ for Tax Purposes by Nick Ravo.

How To Be Eligible For Substantial Tax Savings As A Trader

August 27, 2020 | By: Robert A. Green, CPA | Read it on

There are tax advantages for traders who are eligible for trader tax status (TTS).

  • Learn how to qualify for TTS; no election is required.
  • Automated trading systems can qualify for TTS, providing the trader is significantly involved with the creation. Trade copying software might not be eligible.
  • Learn how to deduct TTS business expenses, startup costs, and home office expenses.
  • Consider a Section 475 election for exemption from wash sales and the $3,000 capital loss limitation and be eligible for a 20% qualified business income deduction on 475 net income if under the QBI income threshold.
  • A TTS S-Corp unlocks health insurance and retirement plan deductions.
  • A TTS LLC/partnership segregates TTS/475 trading from investments made on the individual level.

How to qualify for TTS

Let’s start by taking a deep dive into GreenTraderTax.com golden rules for TTS qualification. Statutory tax law is lacking on TTS, so we analyze tax court cases for traders, and rely on decades-long experience performing tax compliance services for traders.

  1. Volume of trades

The 2015 tax court case Poppe vs. Commission is a useful reference. Poppe made 720 total trades per year/60 per month. We recommend an average of four transactions per day, four days per week, 16 trades per week, 60 trades a month, and 720 per year on an annualized basis. Count each open and closing trade separately, not round trips. Some traders scale into and out of trades, and you can count each of those trades separately.

As an example, the securities markets are open approximately 250 days, but let’s account for some personal days or holidays, and figure you’re available to trade 240 days per year. A 75% frequency of 240 days equals 180 days per year, so 720 total trades divided by 180 trading days equals four trades per day.

What counts? If you initiate a trade order and the broker breaks down the lot sizes without your involvement, it’s wise not to include the extra volume of trades in this case.

Options traders have multi-legged positions on “complex trades.” I believe you may count each trade confirmation of a complex options trade if you enter the trades separately, although the tax court has not addressed that issue yet. Most traders enter a complex options trade, and the broker breaks down the legs, so you cannot count the legs separately. Trade executions count, not unexecuted trades.

  1. Frequency of trades

Execute trades on close to four days per week, around a 75% frequency rate. The tax courts require “regular, frequent, and continuous” qualification for TTS. If you enter or exit a trading business during the year, then maintain the frequency rate during the TTS period. Time off from the execution of trades should be for a reasonable amount of vacations and other non-working days. Think of TTS like it’s a job, only the markets are your boss.

In the following trader tax court cases, the IRS denied TTS to options traders, including Holsinger, Assaderaghi, Endicott, and Nelson. They only traded on two to three days per week; hence, I suggest executing trades on close to four days per week.

  1. Holding period

The IRS stated that the average holding period is the most crucial TTS factor. In the Endicott court, the IRS said the average holding period must be 31 days or less. That’s a bright-line test.

If your average holding period is more than 31 days, it’s disqualifying for TTS, even if all your other TTS factors are favorable.

It’s more natural for day traders and swing traders to meet the holding period requirement. In the holding period analysis, don’t count segregated investment accounts and retirement accounts; only count TTS positions.

Monthly options traders face challenges in holding periods. They may have average holding periods of over one month if they trade monthly and longer expirations and keep them over a month. Holsinger was a monthly options trader, and his holding periods averaged one to two months. More often now, TTS traders are focused on trading weekly options expirations, and many of them are eligible for TTS.

Consider the following example of a trader in equities and equity options. If he holds 80% of his trades for one day and the other 20% for 35 days, then the average holding period is well under 31 days. It’s not evident if the IRS might apply weighted averages to the average holding period.

  1. Trades full time or part-time

Full-time options traders actively trading significant portfolios may not qualify because they don’t have enough volume and frequency, and their average holding period is over 31 days. On the other hand, a part-time trader with a full-time job may qualify as a day and swing trader in securities, meeting all our golden rules.

Part-time and money-losing traders face more IRS scrutiny, and individuals face more scrutiny than entity traders.

  1. Time spent

A TTS trader should spend more than four hours per day, almost every market day working on his trading business. All-time counts, including the execution of trade orders, research, administration, accounting, education, travel, meetings, and more. Most active business traders spend more than 40 hours per week in their trading business. Part-time traders usually spend more than four hours per day.

In one tax exam our firm handled, the IRS agent brought up the “material participation” standard in the passive loss activity rules (Section 469), which require 500 hours of work per year (as a general rule). Most business traders easily surpass 500 hours of work. However, Section 469 doesn’t apply to trading businesses, under its “trading rule” exemption. Without this exemption, taxpayers could generate passive-activity income by investing in hedge funds, and the IRS did not want that.

  1. Avoid sporadic lapses

A trader should have few to no sporadic lapses in the trading business during the year. The IRS has successfully denied TTS in a few tax court cases by arguing the trader had too many periodic lapses in trading, such as taking several months off during the year. Traders can take vacations, sick time, and personal time off just like everyone else. Some traders take a break from active trading to recover from recent losses and learn new trading methods and markets.

Carefully explain breaks in trading to the IRS in tax-return footnotes. Retooling and education during a setback in trade executions still may count for the continuous business activity (CBA) standard, although the IRS has not given credence to CBA for traders in tax court to date. I recommend traders keep proper records of their time spent as support.

Comments from an IRS official about the Chen tax court case point out the IRS doesn’t respect individual traders who are new to trading activity and who enter and exit it too quickly. Chen only traded for three months, while maintaining his fulltime job as a software engineer. He claimed an enormous NOL tax refund based on a massive TTS/475 ordinary loss. The IRS caught him lying about making a timely 475 election, and Chen conceded TTS and the entire case. It’s better to carry on a trading business for a more extended time than Chen did.

Some traders must temporarily stop for several months for health reasons. It’s not clear if the IRS will respect that as a valid interruption of a trading business activity. That seems unfair, but it may be the reality.

Many traders are home from their day jobs with Covid-19 and can carry on a trading business now. But will that active trading continue for the rest of 2020 and into 2021? I’ve noticed a proliferation of “Covid-19 traders,” who started active trading after the Covid correction in March 2020. Many have done well. Employers furloughed or laid-off them off from day jobs, or they have flexible job hours at home. They were attracted to volatility, accessible trading apps, and zero or low commissions.

  1. Intention to run a business

Traders must have the intention to run a trading business — trading his or her own money — but it doesn’t have to be one’s exclusive or primary means of making a living. The keyword is “a” living, which means it can be a supplemental living.

Many traders enter an active trading business while still working a full-time job. Advances in technology and flexible job schedules make it possible to carry on both activities simultaneously.

It’s not a good idea to try to achieve TTS within a business entity, already principally conducting a different type of business activity. It’s better to form a new trading entity. Trading an existing business’s available working capital seems like a treasury function and sideline, which can deny trader tax breaks if the IRS takes a look.

Filing as a sole proprietor on a Schedule C is allowed and used by many, but it’s not the best tax filing strategy for a part-time trader. An individual tax return shows a taxpayer’s job and other business activities or retirement, which may undermine TTS in the eyes of the IRS. The IRS tends to think trading is a secondary activity, and it may seek to deny TTS. It’s best to form a new, separate entity dedicated to trading only.

Several years ago, we spoke with one IRS agent who argued the trader did not make a living since he had perennial trading losses. That’s okay because the rule looks to intention, not the actual results. The hobby-loss limitations don’t apply to TTS traders because trading is not recreational or personal. Part-time traders often tell me they operate a business to make a supplemental living and intend to leave their job to trade full-time when they become profitable enough.

  1. Operations

A TTS trader has significant business equipment, education, business services, and a home office. Most business traders have multiple monitors, computers, mobile devices, cloud services, trading services, and subscriptions, education expenses, high-speed broadband, wireless, and a home office and/or outside office. Some have staff.

The IRS needs to see that a taxpayer claiming TTS has a realistic trading business operation.

How can one run a business without a dedicated space? Casual investors rarely have as busy an office set up as business traders do. Why would a long-term investor need multiple monitors?

If a trader uses a home-office space exclusively for business rather than personal use, the tax return should reflect this because it is not only a valid home-office deduction, but it also further supports the fact there is a legitimate business activity being conducted. The home-office deduction is no longer a red flag with the IRS, and it is not a complicated calculation. Most of the home-office deduction requires income, in this case, TTS trading gains. Some TTS traders just use a laptop, and that’s okay.

  1. Account size

Securities traders need to have $25,000 on deposit with a U.S.-based broker to achieve “pattern day trader” (PDT) status. With this status, he or she can day trade using up to 4:1 margin rather than 2:1. Without PDT status, securities traders, which include equities and equity options, will have a more challenging time qualifying for TTS. I like to see more than $15,000 account size for trading futures, forex, or cryptocurrency.

Adequate account size also depends on one’s overall net worth and cash flow. Millionaires may need larger account sizes, whereas some unemployed traders without much cash flow or very young traders may get by with smaller account sizes. A trader may also be able to factor in capital invested in equipment and startup costs.

What doesn’t qualify for TTS

Don’t count these four types of trading activity for TTS qualification:

  • Automated trading systems (ATS) without much involvement by the trader (but a trader creating an ATS qualifies);
  • A trade copying software or service;
  • Engaging a professional outside investment manager;
  • And trading in retirement funds.

Do not include these trades in the golden rule calculations.

  1. Outside-developed automated trading systems

These programs are becoming more popular. An entirely canned ATS with little to no involvement by the trader doesn’t qualify for TTS. The IRS may view an outside-developed ATS the same as a trader who uses a broker to make most buy/sell decisions and executions.

If the trader can show he’s very involved with the design and building of the ATS, then the IRS may count the ATS-generated trades in the TTS analysis. That includes but is not limited to writing the code or algorithms and setting the entry and exit signals. Self-creation of the ATS needs to be significant to count for TTS. Just making a few choices among options offered in an outside-developed ATS building-block service does not qualify for TTS.

Some traders don’t have programming experience, but they have financial and trading experience. They design the ATS to do what they do manually as a trader and hire an outside programmer to translate their specifications into a computer language.

It’s helpful if the trader can show he spends more than four hours per day working in his trading business, including time for ATS maintenance, back-testing, and modifications. I have not yet seen the IRS challenge ATS for TTS in exams or court cases, but I feel it may react this way when it comes up.

If traders spend a lot of money on an ATS that doesn’t qualify as part of their trading business, then those expenses are suspended investment expenses under TCJA. Traders need to know the IRS may connect the dots and realize they are using an ATS. A full-scale exam can uncover these facts. Consider the analogy of an airplane pilot using manual and automated systems. A trader needs to be a pilot in the cockpit, not in the cabin as a passenger.

  1. Trade copying software or service

Some traders use trade copying software or service (TCS). Trade copying is similar to using a canned ATS or outside adviser, where the copycat trader might not qualify for TTS on those trades. As an example, a trade coaching and education company offers a TCS that suggests several trades each day, with exact entry and exit points and stop-loss orders. The trader decides which trades to make and executes them manually.

If the trader follows the TCS tightly and does not significantly depart from its suggestions, then an IRS agent might feel that he or she does not qualify for TTS. On the other hand, if the trader cherry-picks a minor percentage of the suggested trades, sets different stop-loss orders, and waits longer on entry and exit executions, then he or she might qualify for TTS. The TCS vendor might state they are not providing investment management services, but that does not mean their customer achieves TTS using the TCS.

  1. Engaging a money manager

Hiring a registered investment adviser (RIA) or commodity trading adviser (CTA) — whether they are duly registered or exempt from registration — to trade one’s account doesn’t count toward TTS qualification. However, hiring an employee or independent contractor under the trader’s supervision to help trade should qualify, providing the taxpayer is a competent trader. There are decades-old tax court cases that show using outside brokers and investment advisers to make trading decisions undermines TTS.

There are differences between hiring an independent investment manager vs. a supervised assistant trader. If the engaged trader is a registered investment adviser, he’s clearly in the business of being an external manager, and TTS is not achievable. But if the person only assists a retail trader under the account holder’s direction and supervision, it may be possible to achieve TTS. It’s okay to have a co-pilot in the TTS cockpit.

With married couples, if spouse A has an individual brokerage account in his or her name only and gives power of attorney to spouse B to trade it, the IRS won’t grant TTS even if spouse B meets all the golden rules for TTS. Spouse B is not an owner of the account, so that the IRS will treat spouse A as an investor and spouse B as an investment manager. Married couples can solve this problem by using a joint individual account or trading in a spousal-owned entity.

  1. Trading retirement funds

You can achieve TTS through taxable trading accounts only. Trading activity in non-taxable retirement accounts doesn’t count for purposes of TTS qualification. Trading in retirement plans can be an excellent way to build tax-free compounded returns, especially if the taxpayer doesn’t qualify for TTS in their taxable accounts.

It is possible to trade retirement accounts and, at the same time, qualify for TTS in taxable accounts.

Caution: it’s dangerous to trade substantially identical positions between an individual taxable account and IRA accounts since this can trigger a permanent wash-sale (WS) loss in a taxable account that moves into the IRA. Avoid permanent WS losses in IRAs with a Section 475 election on the taxable account or use a Do Not Trade List to avoid overlap in the IRAs.

Sole proprietorship with TTS

An individual TTS trader deducts business expenses, startup costs, and home office deductions on a Schedule C (Profit or Loss From Business – Sole Proprietorship) 1040 filing. Traders don’t have revenue on Schedule C; report trading gains and losses on other tax forms. Schedule C expenses are an above-the-line deduction from gross income. TTS Schedule C expenses reduce self-employment income (SEI). Although, trading income is not SEI, and traders don’t owe SE tax in connection with trading income. There isn’t a tax election for claiming TTS. — it’s determined based on facts and circumstances assessed at year-end. You can claim TTS after-the-fact; you don’t have to formalize it in advance.

Business expenses include home-office, education, startup expenses, organization expenses, margin interest, tangible property expense, Section 179 (100%) or 100% bonus depreciation, amortization on software, self-created automated trading systems, chat rooms, mentors, seminars, market data, charting services, stock borrow fees, and much more.

Section 475 tax benefits

TTS traders are entitled to make a Section 475 election, but investors may not. The 475 election exempts securities trades from wash-sale loss (WS) adjustments, which can defer tax losses to the subsequent year, and the $3,000 capital loss limitation. Ordinary loss treatment is better; it can generate tax refunds faster than capital loss carryovers. There are also benefits on 475 income: a 20% QBI deduction if under the taxable income threshold for a service business.

The deadline for an individual to elect Section 475 for 2020 has passed; it was July 15, 2020, the postponed deadline. A partnership or S-Corp formed during the tax year is considered a “new taxpayer,” which can elect Section 475 internally within 75 days of inception. A new entity comes in handy for electing 475 after July 15, 2020. It’s too late to select 475 for 2019; that election deadline was April 15, 2019.

I usually recommend 475 on securities only to retain lower 60/40 capital gains rates on Section 1256 contracts. Section 475 does not apply to segregated investment positions. Avoid overlap of substantially identical positions in what you trade versus what you invest in taxable accounts, as that allows the IRS to recharacterize trades vs. investments. You can fix this potential problem by ring-fencing TTS/475 in a new entity and leaving investment positions on the individual level.

The qualified business income deduction

TCJA introduced a tax benefit for pass-through businesses, which includes a TTS trader with Section 475 income, whether doing business as a sole proprietor, partnership, or S-Corp. Section 199A provides a 20% QBI deduction on a “specified service trade or business” (SSTB), and TTS trading is an SSTB. SSTBs are subject to a taxable income threshold, phase-out range, and an income cap. The phase-out has wage and property limitations, too.

LLC taxed as an S-Corp

Organize a single-member or spousal-member LLC and elect S-Corp status with the IRS within 75 days of inception. Alternatively, in a subsequent year, the LLC can submit an S-Corp election by March 15. Owners must be U.S. residents. The S-Corp can elect Section 475 internally within 75 days of inception.

TTS traders with significant health insurance (HI) premiums should consider an S-Corp to arrange a tax deduction through officer compensation. Otherwise, the trader or spouse might have another source of self-employment income to deduct HI. A spouse might have HI coverage for the family in their job. Cobra is not deductible HI since its employer provided. A TTS sole proprietor or partnership cannot deduct HI based on trading income.

Traders need earned income to make and deduct HI and retirement plan contributions; however, trading income is unearned. TTS sole proprietors and partnerships cannot create earned income, whereas S-Corps can pay officer compensation, generating earned income.

Payroll taxes apply on officer compensation (wages), except for the HI component of salary: 12.4% FICA capped on wages up to $137,700 for 2020, and the 2.9% Medicare is unlimited.

TTS traders should fund retirement plan contributions from net income, not losses. It’s best to wait on the execution of an annual paycheck until early December when there is transparency for the year.

If you have sufficient trading profits for the year, consider establishing a Solo 401(k) retirement plan before year-end. Start with the 100% deductible elective deferral (ED; $19,500 for 2020) and pay it through payroll since on the annual W-2. Taxpayers 50 years and older have a “catch up provision” of $6,500, raising the 2020 ED limit to $26,000 per year. Contribute the elective deferral to a Solo 401(k) Roth or traditional account.

If you have significant trading gains, consider increasing payroll to unlock a Solo 401(k) profit-sharing plan (PSP) contribution. You don’t have to pay into the retirement plan until the due date of the S-Corp tax return (including extensions by September 15). The maximum PSP amount is $37,500 on wages of $150,000 ($37,500 divided by 25% equals $150,000). The total limit for a Solo 401(k) is $63,500 ($19,500 ED, $6,500 catch-up ED, and $37,500 PSP).

LLC taxed as a partnership

A TTS trader can organize a spousal-member LLC and file as a partnership. LLC/partnerships file a Form 1065 partnership tax return and issue Schedule K-1s to owners. LLC/partnerships must qualify for TTS; otherwise, they are investment companies.

A partnership is useful for ring-fencing TTS/475 trading from individual taxable, and IRA accounts for avoiding wash sale losses and the IRS reclassifying investment positions as TTS/475 positions.

Active trading gained popularity in 2020, and many people are eligible for trader tax status benefits.

This article references to content in Green’s 2020 Trader Tax Guide.

Watch our related recording: How To Be Eligible For Substantial Tax Savings As A Trader

If SCOTUS Rules Against ACA It Could Trigger Tax Refunds

July 14, 2020 | By: Robert A. Green, CPA

By CPAs Darren Neuschwander and Robert A. Green

If you paid the Affordable Care Act (ACA) Medicare surtaxes on unearned or earned income in 2016 through 2019, you might be eligible for a potential tax refund if the Supreme Court of the United States (SCOTUS) rules against ACA. SCOTUS agreed to take the ACA case, and experts expect a decision in early 2021. Traders have unearned income, and they pay the ACA 3.8% Medicare surtax on net investment income over the AGI threshold (see below).

Act fast for 2016
Some taxpayers need to act fast before SCOTUS renders their decision about ACA. If you paid ACA taxes on your 2016 income tax return and filed that return by its original due date of April 18, 2017, then consider submitting a “protective claim for refund” due by July 15, 2020. That’s the date the 2016 tax year closes, three years from April 18, 2017, the original tax return deadline, plus the three-month postponement under the CARES Act. A protective claim for refund extends the deadline for purposes of this ACA refund, giving you ample time to react to the SCOTUS decision. If you miss the July 15, 2020 deadline, at least you can still submit the protective claim for 2017, 2018 and 2019,

If you filed an extension for 2016 taxes, extending the deadline six-months until October 15, 2017, you have three years from the actual filing date up to October 15, 2020. For example, if you filed your 2016 income tax return on August 30, 2017, the tax year closes three years later on August 30, 2020.

There’s no rush to submit a protective claim for refund of ACA taxes for 2017, 2018, and 2019 tax returns. The 2017 tax year would close April 15, 2021, unless you filed a 2017 tax extension until October 15, 2018, in which case the year closes three years after filing date.

ACA taxes and potential refunds
If SCOTUS rules against ACA, it could trigger this refund opportunity for ACA taxes paid in 2016 through 2019.

These ACA taxes include the 0.9% Medicare Surtax on earned income (Form 8959) and 3.8% Net Investment Income Taxes on unearned income (Form 8960) for 2016 through 2019. The ACA net investment tax applies to individuals with net investment income (NII) and modified adjusted gross income (AGI) exceeding $200,000 single, $250,000 married filing jointly, or $125,000 married filing separately. ACA law does not index the threshold for inflation.

Filing a protective claim ensures that if SCOTUS invalidates ACA taxes, taxpayers who paid them could formalize a refund request, even after the amended tax return filing deadline closes. Congress could enact a statute that would allow (or require) the IRS to issue refunds for closed tax years even without filing a protective claim.

We cannot assess the likelihood that these ACA taxes will be deemed unconstitutional retroactively to these years, but we wanted to bring the possibility to your attention.

Here’s a template of the informal protective claim for refund if you decide that you would like to submit it to the IRS for tax year 2016. It should be mailed (preferably by certified mail, return receipt, if available at your local post office) to the IRS service center within the PDF file based on your current mailing address.

We are available for questions on this matter after July 15, 2020, the postponed tax deadline.

Adam Manning CPA contributed to this blog post.