Author Archives: Robert Green

It’s Hard For Traders To Move Out Of New York For Tax Purposes

May 3, 2024 | By: Robert A. Green, CPA | Read it on

In today’s digital world, some people, especially traders, can operate their economic activities while traveling around the U.S. and the world. Some land in one place and change tax domicile, while others continue traveling and never establish a new domicile. The problem is that some states, like New York and California, continue to subject people to resident taxation until they change their domicile.

Historically, in an inter-state move, a family hired a shipper to move their home contents from a prior permanent home to a new one in another state. In that case, their domicile changed on the moving date. It gets more complicated when the family moves their home contents to storage and starts their travels for months or even years.

For example, a family moved out of a New York State home in February 2024 but doesn’t plan to move into their new home in Florida until October 2024. They are spending the interim months traveling around the country and the world. NYS would likely consider this taxpayer a part-year resident until the actual move-in date in Florida in October 2024 and a non-resident of NYS after that date.

The new permanent home requirement with a change of domicile seems unreasonable when the interim months turn into years or never happen. People can move freely without the physical realities of historic domicile rules crafted before the Internet and remote working revolution.

Domicile and tax resident vs. non-resident rules vary by state; most have subjective and objective tests. State tax auditors focus on enforcing residency rules.

New York State domicile rules
NYS subjects domiciled residents with resident taxation on worldwide income reported on Form IT-201. People domiciled in other states but working in NYS file a non-resident Form IT-203 reporting NYS-source income, including wages and business income, but not portfolio income. Telecommuting to a virtual job in an NYS office from an out-of-state domicile is considered NY-source income filed on an NYS non-resident tax return. (there is a “convenience of the employer rule”)

Some assume that moving out of state might be enough to stop owing NYS resident taxes. They are wrong. NYS requires residents to complete a move with a change of domicile, which includes establishing a new permanent home in a new state or country. Some taxpayers don’t achieve these requirements and are stuck in limbo.

See the New York State Department of Taxation and Finance publication 88: General Tax Information for New York State Nonresidents and Part-Year Residents. (Read the domicile rules on pages 5 – 8).

“You can have only one domicile. Your New York domicile does not change until you can demonstrate that you have abandoned it and established a new domicile outside New York State.”

  • “A change of domicile must be clear and convincing. Easily controlled factors such as where you vote, where your driver’s license and registration are issued, or where your will is located are not primary factors establishing domicile. To determine whether you have, in fact, changed your domicile, you should compare:
    • the size, value, and nature of use of your first residence to the size, value, and nature of use of your newly acquired residence;
    • your employment and/or business connections in both locations,
    • the amount of time spent in both locations;
    • the physical location of items that have significant sentimental value to you in both locations; and
    • your close family ties in both locations.”

Many people living and working in New York City purchase a second home just outside the city in the tri-state area. Some are tempted to change their domiciles outside NYC, which piggybacks NYS domicile rules. The above factors apply in determining if a second home passes muster as a primary permanent home for a change of domicile. A goal is to avoid NYC resident taxation which ranges from 3.078% to 3.876%.

There are two exceptions to the NYS domicile rules: the 30-day test for days spent in NYS and the 548-day test for time spent while traveling outside the U.S. The 30-day test requires a new permanent home, whereas the 548-day test for international travel does not.

“Even if your domicile is New York State, you are not a resident if you meet all three conditions in either Group A or Group B as follows:”

The 30-day test: (Group A)

“1. You did not maintain any permanent place of abode in New York State during the tax year; and

  1. You maintained a permanent place of abode outside New York State during the entire tax year; and
  2. You spent 30 days or less (a part of a day is a day for this purpose) in New York State during the tax year.”

The 548-day test: (Group B)

“A New York domiciliary can be treated as a nonresident if they:

-Are present in a foreign country or countries for at least 450 days out of a 548-day period.

-Spend 90 days or less in New York during that 548-day period, along with their spouse and minor children.

-During any partial calendar year within the 548-day period, the ratio of days spent in New York vs. the total days in that partial year does not exceed the ratio of the partial year days to 548 days.” (See an example in the NYS law here.)

NYS statutory resident test

  • “Generally, if your domicile is not New York State you are considered a New York State nonresident. However, you are a New York State resident for income tax purposes if your domicile is not New York State, but you maintain a permanent place of abode in New York State for more than 11 months of the year and spend 184 days or more (any part of a day is a day for this purpose) in New York State during the tax year.”

New Yorker moves to Florida
These past few years, heightened by the COVID-19 pandemic, many traders and hedge fund employees moved from high-tax states, including New York and Connecticut, to Florida, which does not have an income tax. Others moved from high-tax California to Washington and Texas, which also don’t have an income tax.

Some NYS “snowbirds” are reckless in applying the stringent rules for changing domicile. For example, they might keep their permanent large home in NYS, where they have a closer connection in business and family matters, and buy or rent a small apartment in Florida, barely meeting the 183-day requirement for becoming a Florida resident. If NYS considers that they never changed domicile from NYS to Florida, then its 30-day test applies, not the NYS 183-day statutory residence test.

State domicile rules are complex and involve many subjective factors. Each case can be different, and it’s based on the taxpayer’s intent, facts, and circumstances. Many over-rely on objective formalities like voting and license and underweight subjective factors like family, relative home values, and closer connections.

Relying on antiquated domicile rules crafted before modern technologies and newer ways of living and working is unfair.

Prompt questions for an  AI engine:

  • What are the rules for a change of domicile in New York State?
  • I moved out of NYS to travel and never established a new permanent home. Will NYS tax authorities still consider me domiciled in NYS?

Links:

Star Johnson, CPA, contributed to this blog post. 

 

 

The Tax Cuts And Jobs Act Mainly Expires In 2025

April 29, 2024 | By: Robert A. Green, CPA | Read it on

Most of the tax changes in the 2017 Tax Cuts & Jobs Act (TCJA) expire (sunset) at the end of 2025. TCJA featured tax cuts and some tax hikes to help pay for it. Meanwhile, TCJA’s massive tax cut lowering the corporate tax rate to 21% does not expire.

Accountants and taxpayers have grown accustomed to TCJA, although they were whipsawed by the 2020 CARES Act, which temporarily forestalled several tax-hike provisions. Switching back to pre-TCJA law starting in tax year 2026 might be awkward, and it could become confusing if Congress turns tax law upside down again.

With a lame-duck-divided 2024 Congress, I don’t expect significant tax law changes until 2025, when most TCJA provisions expire. I also don’t expect Congress to implement substantial tax law changes until the last minute before the 2025 year-end fiscal cliff. The November 2024 presidential and Congressional election might give us clues about coming tax changes.

TCJA permanent provision:

The 21% corporate flat tax rate enacted under the TCJA is permanent and does not expire. Before the TCJA, the federal corporate income tax rate was graduated, with a top marginal rate of 35%. Lowering the corporate rate was the principal tax cut in TCJA.

Pass-through entities (PTE) like LLC/partnerships and S-Corps don’t qualify for the corporate tax break, so Congress equalized PTE businesses with a 20% qualified business income deduction (QBID). However, QBID sunsets in 2025.

Will the 2025 Congress consider extending QBID, provided they don’t increase the corporate tax rate? QBID has been a complex tax compliance issue for taxpayers and tax professionals. Many small businesses at all income levels benefit from QBI.

TCJA sunset provisions:

Most of TCJA’s tax cuts and tax-hike provisions were initially set to expire in 2025.

The list below includes some of these provisions. For a complete list of expiring tax provisions in TCJA, see Congressional Research Services (CRS) Reference Table: Expiring Provisions in the “Tax Cuts and Jobs Act.”

Marginal tax rates—The lower marginal tax rates in TCJA expire at the end of 2025. Individual tax rates will return to pre-TCJA levels starting in 2026. It’s important to note that lower TCJA tax rates apply throughout the marginal tax brackets, helping taxpayers at all income levels.

“Marginal rates will revert to their permanent pre-TCJA levels of 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%. Aside from the first two brackets (10% and 15%) these rates apply over different ranges of taxable income than the TCJA rates. These income ranges are annually adjusted for inflation,” per the CRS report.

Increased standard deduction—TCJA’s roughly doubled standard deduction (indexed for inflation) returns to pre-TCJA levels on January 1, 2026. Looking back, Congress achieved its goal of more taxpayers using the standard deduction, making tax compliance more accessible and straightforward.

“The basic standard deduction amounts will revert to their TCJA levels and then be adjusted for inflation. For 2018, prior to the TCJA, the basic standard deduction amounts for 2018 would have been $6,500 for single filers, $9,550 for head of household filers, and $13,000 for married taxpayers filing jointly,” per CRS report.

Itemized deductions—Before the TCJA, taxpayers could deduct many more itemized deductions on Schedule A. This included “miscellaneous itemized deductions” over 2% of adjusted gross income (AGI), including investment expenses, unreimbursed employee business expenses, and tax compliance expenses. Before TCJA, alternative minimum tax (AMT) disallowed miscellaneous itemized deductions.

Of the few allowed itemized deductions, TCJA reduced and revised them. See the CRS report for mortgage interest deductions and changes in charitable deductions. TCJA suspended personal casualty losses as itemized deductions, except for losses in a federally declared disaster area.

Active traders eligible for trader tax status (TTS) deduct trading business expenses on Schedule C as sole proprietors, bypassing Schedule A. TTS traders also deduct business expenses on pass-through entity tax returns. TTS was better than investor status before and during the TCJA, and it should stand up well to tax changes coming next year.

State and local taxes— TCJA limits a SALT itemized deduction to $10,000, which led many taxpayers to take the roughly doubled standard deduction instead of itemizing. The SALT cap was not indexed for inflation.

Starting in 2026, the $10,000 cap will not apply, and taxpayers can deduct all eligible state and local income, sales (instead of income), property taxes, and foreign income taxes. They will also be able to deduct foreign real property taxes. AMT does not allow a state and local tax itemized deduction.

Pass-through entities (PTE), including partnerships (general, limited, and LLCs) and S-corps, can utilize a SALT cap workaround in more than 30 states. The workaround treats PTE state tax payments as business expenses rather than non-deductible SALT payments. The taxpayer takes a tax credit on their state tax return for the entity-level PTE payments, thereby avoiding double taxation. California’s SALT cap workaround expires in 2025 in sync with TCJA’s SALT cap expiration.  The SALT cap workaround in other states may expire as well.

20% qualified business income deduction (QBID)—The QBID for non-corporate business owners, including sole proprietors, partnerships, LLC/partnerships, and S-Corps, expires at the end of 2025. It is a significant tax cut for small businesses, especially those not classified as a “specified trade or business” (SSTB).

Traders eligible for TTS are SSTB. TTS expenses and Section 475 ordinary trading income or loss are included in QBI, excluding capital gains and losses, and portfolio income. Many traders have received a QBID tax benefit.

Excess business losses (EBL)—The TCJA created the EBL limitation for 2018 through 2025 as a tax hike to help pay for the TCJA tax cuts. Subsequent legislation extended the EBL expiration date to 2028. The 2020 CARES Act delayed the EBL, pushing the start date to 2021. 

Under TCJA, add the excess business losses over the EBL threshold to a net operating loss (NOL) carryforward.

The EBL is inflation-adjusted; it’s $610,000 (for joint returns)/$305,000 (for other taxpayers) for 2024. When this provision expires, there will be no EBL limitation.

EBL includes TTS expenses and Section 475 ordinary trading losses for TTS traders. Section 475 gains can offset other business losses before applying the EBL limitation.

Net operating losses (NOLs)—The TCJA, as a tax hike, repealed two-year NOL carrybacks and revised NOL carryforwards. However, CARES temporarily allowed five-year NOL carrybacks for 2018 through 2020. TCJA NOL rules came back in effect for 2021 through 2025.

TCJA limits NOL carryforwards to 80% of taxable income (100% pre-TCJA), with the balance carrying over to the subsequent year (limited to 20 years pre-TCJA). In 2026, two-year NOL carrybacks and the 100% NOL carryforward rules will apply.

Increased estate exemption—TCJA’s roughly doubled unified estate and gift tax exemption amount will return to the pre-TCJA amount of $5 million (indexed for inflation) as of January 1, 2026. That inflation-adjusted amount for 2026 is expected to be approximately $7 million. That’s a significant reduction from the 2024 unified estate and gift tax exemption of $13.61 million.

With an estate portability election, a married couple can have an exemption of up to $27.22 million for 2024. Post-TCJA, it could be around $14 million. The estate amount over the exemption amount is subject to a 40% federal estate tax.

Don’t overlook state estate taxes. Twelve states (and DC) have estate tax laws, and six have an inheritance tax. Eight states have an estate tax rate of 16%, a few are 12%, and Washington and Hawaii are 20%. For 2024, Connecticut matches the federal exemption amount but does not allow surviving spouse exemption portability. Other states range between $1 million for Oregon and $6.9 million for New York.

Star Johnson, CPA, contributed to this blog post.

Tips For Traders On Preparing 2023 Tax Returns

March 7, 2024 | By: Robert A. Green, CPA | Read it on

Trader tax status (TTS) constitutes business expense treatment, unlocking meaningful tax benefits for qualified active traders. The first step is to determine eligibility.

If you qualify for TTS, you can claim some tax breaks, such as business expense treatment, after the fact and elect and set up other tax breaks—like Section 475 MTM and employee-benefit plans (health and retirement)—on a timely basis.

TTS business expenses
If you qualified for TTS in 2023, you could claim business expenses on Schedule C. No IRS election was required. Schedule C is part of an individual tax return (Form 1040).

On an S-Corp or partnership tax return, deduct TTS business expenses on page 1 from ordinary business income. (Business expenses are not separately stated items on Schedule K-1).

Please have a look at the GreenTraderTax Center for a list of TTS business expenses.

Section 475: MTM accounting
Don’t confuse TTS business expenses with a Section 475 MTM accounting election that a TTS trader could have submitted by April 18, 2023, for the tax year 2023. (Or, if elected in a prior year.)

The 475 election is like graduate school, and TTS is like undergraduate university; you need TTS to make and use a 475 election.

Without a timely 475 election, it’s too late to avoid wash sale losses and the $3,000 capital loss limitation. And there’s no qualified business income (QBI) deduction on capital gains; QBI is allowed on Section 475 income.

How to qualify for trader tax status
The volume of trades: We recommend an average of four transactions per day, four days per week, 16 trades per week, 60 a month, and 720 annually. Count each open and closing transaction separately, not round-trip. Scaling in and out counts, too. If the broker breaks down the trades into smaller lot sizes, don’t count those extra lot sizes.

While a full year looks better, a partial year is okay. We prefer that you establish TTS for a minimum of Q4. For example, start TTS by October 1, 2023, and continue TTS well into 2024.

Frequency: Execute trades on nearly four weekly days, around a 75% frequency rate.

Holding period: In the Endicott Court, the IRS said the average holding period must be 31 days or less. That is a bright-line test.

Segregate investments: It is wise to segregate investments from trading. Otherwise, the IRS could consider the long investment holding periods, which can make the average holding period over 31 days, undermining qualification for TTS.

Trades full-time or part-time a good portion of the day. Part-time and money-losing traders face more IRS scrutiny. Part-year qualification for TTS is okay.

Hours: Spends more than four hours daily, almost every market day, working on their trading business.

Avoid sporadic lapses: A trader has few to no intermittent stoppages during the trading year. Vacations are okay.

Intention: Has the intention to run a business and make a living. It doesn’t have to be your primary source of income.

Operations: Has significant business equipment, education, business services, and a home office.

Account size: Securities traders need to have $25,000 on deposit with a U.S.-based broker to achieve “pattern day trader” (PDT) status. We want to see over $15,000 for the minimum account size for trading futures.

For more information, see Trader Tax Status: How To Qualify.

Tax reporting for a sole proprietorship trading business
The IRS uses multiple tax forms for trading businesses eligible for trader tax status (TTS). It can be confusing to taxpayers, accountants, and the IRS. Traders enter gains and losses, portfolio income, and business expenses in various tax forms.

Which tax form or schedule should a forex trader use? It depends on their circumstances. Which form is correct for securities traders using the Section 475 MTM method? Can trading gains be reported directly on Schedule C? The different reporting strategies for the various types of traders make tax time more manageable.

Schedule C
Most sole-proprietorship businesses report revenue, cost of goods sold, and expenses on Schedule C. The IRS can quickly determine whether they are profitable but cannot do so with sole proprietorship traders.

Traders qualifying for TTS report only trading business expenses on Schedule C. Trading gains and losses are reported on other tax forms, depending on the situation.

If possible, it’s helpful to include a tax return footnote tying the trader’s schedules together to show profitability.

Consider the transfer strategy, which moves some trading gains to Schedule C (other income) to break even and not show a profit.

Schedule D and Form 8949
Sales of securities for each trade are reported on Form 8949, which feeds into Schedule D.

Net capital losses against ordinary income are limited to $3,000 per year. The rest is a capital loss carryover. Capital losses are unlimited compared to capital gains.

If you have significant capital loss carryovers going into 2024 and substantial trading gains by April 15, 2024, consider skipping a 2024 Section 475 election due on that date. That would convert trading income to ordinary income, not using up the capital loss carryover.

Form 8949 and wash sale reporting
See Form 8949 and the IRS instructions for Form 8949:

“Exception 1. Form 8949 isn’t required for certain transactions. You may be able to aggregate those transactions and report them directly on either line 1a (for short-term transactions) or line 8a (for long-term transactions) of Schedule D. This option applies only to transactions (other than sales of collectibles) for which: • You received a Form 1099-B (or substitute statement) that shows basis was reported to the IRS and didn’t show any adjustments in box 1f or 1g. ”

Most traders generate wash sale loss (WS) adjustments, which are reported on boxes 1f and 1g, so 1099-Bs with WS don’t meet the above exception; the trader must report each trade on Form 8949.

See Securities, Accounting Solutions, and Form 8949 & 1099-B Issues.

Schedule 4797 for MTM accounting
TTS traders who elected and have Section 475 MTM on securities report each securities trade on Form 4797 Part II.

MTM accounting means open securities trades are marked-to-market at year-end prices.

Form 4797 Part II receives ordinary gain or loss treatment, avoiding the capital loss limitation and wash-sale loss rules. (It’s “tax loss insurance.”)

Profitable traders can also benefit from Section 475, which includes a 20% qualified business income (QBI) deduction. With QBI, there are thresholds and caps.

Section 475 Election
Existing taxpayers file a Section 475 election statement with the IRS by the due date of the prior year’s tax return or extension and perfect it later with a Form 3115 (change in accounting method) filing by the tax return deadline, including extension.

You’ll be able to learn about making a Section 481(a) adjustment to convert from the realization to the MTM method of accounting.

A Section 475 election for 2023 was due by April 18, 2023. The next opportunity to elect 475 is in 2024, by April 15, 2024. Learn the nuances of making a 475 election here.

“New taxpayers” (like a new entity) can elect Section 475 by internal resolution (not with the IRS) within 75 days of inception. New taxpayers don’t file Form 3115 since they have adopted the 475 MTM accounting method.

Net operating losses (NOL)
In 2018, the Tax Cuts and Jobs Act (TCJA) repealed the two-year NOL carryback, except for certain farming losses and casualty and disaster insurance companies.

The TCJA carries forward NOLs indefinitely (20 years before the TCJA changes).

The NOL deduction is limited to 80% of the subsequent year’s taxable income. 

Excess business losses (EBL)
In 2018, the TCJA introduced an excess business loss (EBL) limitation.

The 2020 CARES Act suspended TCJA’s EBL and NOL changes for 2018, 2019, and 2020 and allowed five-year NOL carrybacks (i.e., a 2020 NOL carryback to 2015).

TCJA’s EBL and NOL carryforward rules apply for tax years 2021 through 2028.

The inflation-adjusted 2023 EBL threshold is $578,000 (married)/$289,000 (other taxpayers), and the 2024 EBL threshold is $610,000 (married)/$305,000 (other taxpayers).

Add the excess over the EBL threshold to an NOL carryforward.

Deduction on qualified business income (QBI)
In 2018, TCJA introduced a new tax deduction for pass-through businesses, including sole proprietors, partnerships, and S-Corps. Subject to haircuts and limitations, a pass-through business could be eligible for a 20% deduction on qualified business income (QBI).

TTS traders are considered a “specified service trade or business” (SSTB), so taxable income above the following thresholds is not deductible: $364,200/$182,100 (married/other taxpayers) for 2023 and $383,900/$191,950 (married/other taxpayers) for 2024.

There is also a phase-out range above the threshold of $100,000/$50,000 (married/other taxpayers). The W-2 wage and property basis limitations apply within the phase-out range. TTS traders with an S-Corp usually have wages, whereas sole proprietorship traders do not.

QBI for traders includes Section 475 on ordinary income, loss, and trading business expenses. QBI excludes capital gains and losses, Section 988 forex income or loss, dividends, and interest income.

See IRS Form 8995 and 8995-A.

Schedule 6781 for futures
Section 1256 contract traders (i.e., futures) should use Form 6781 (unless they elected Section 475 for commodities/futures; those are reported on Form 4797).

Section 1256 traders rely on a one-page Form 1099-B showing their net trading gain or loss (aggregate profit or loss on contracts) using mark-to-market accounting. That amount is entered in summary format on Form 6781, Part I.

Section 1256 contracts enjoy lower 60/40 capital gains tax rates: 60% (including day trades) is subject to lower long-term capital gains rates, and 40% is taxed as short-term capital gains using the ordinary rate. 

At the maximum tax bracket for 2023, the blended 60/40 rate is 26.8%—10.2%—lower than the highest regular bracket of 37%.

Most futures traders skip a Section 475 election to retain 60/40 capital gains rates.

If a trader or investor has a significant Section 1256 loss, they should consider carrying it back for three tax years but only apply it against Section 1256 gains in those years. To make this election, check box D labeled “Net Section 1256 contracts loss election” on the top of Form 6781 filed on a timely basis.

Please take a look at Section 1256 Contracts.

Digital assets, including cryptocurrencies
For sales of digital assets, including cryptocurrencies, use Form 8949.

Digital assets are not subject to wash sale loss rules or Section 475 MTM because the IRS treats digital assets as ”intangible assets,” not securities or commodities.

Be sure to answer the IRS question on tax returns about digital assets. See https://www.irs.gov/newsroom/taxpayers-should-continue-to-report-all-cryptocurrency-digital-asset-income.

For more information, see Cryptocurrencies.

Tax treatment for financial products
I cover tax treatment for U.S. and international equities, U.S. futures, and other Section 1256 contracts, options, ETFs, ETNs, forex, precious metals, foreign futures, cryptocurrencies, and swap contracts. See Tax Treatment On Financial Products.

It’s important to distinguish between securities vs. Section 1256 contracts with lower 60/40 capital gains rates vs. other financial products such as forex or swaps with ordinary income or loss treatment. Various elections are available to change tax treatment.

Form 1099-B and wash sale loss adjustments
Proceeds, minus cost basis, plus wash sale loss adjustments, equal net trading gain or loss using the realization method.

For example, the WS loss column could be $500,000, but most of that amount might be included in the cost basis column, so most wash sales are closed. What matters is how much of the WS loss is open and deferred to the subsequent tax year.

Buying back a losing A December 2023 trade within 30 days of January 2024 triggers a 2023 WS loss.

Using Section 475 MTM accounting, a TTS trader avoids WS loss adjustments and the $3,000 capital loss limitation. It’s okay to depart from the 1099-B.

See Wash Sale Losses.

I have recommended TradeLog (TL) every year since 2001, when I helped bring Section 475 MTM accounting to the program.

Use TL to download your trade history from your broker’s website (not the 1099-B) and calculate WS according to IRS rules for taxpayers. TradeLog can also calculate WS according to IRS rules for brokers and should match broker 1099-Bs.

TL generates Form 8949 or Form 4797 (for Section 475 MTM).

You can license the TL software to do the trade accounting. Alternatively, TL can do this trade accounting for you as a service.

Green, Neuschwander & Manning, LLC (GNM) offers trade accounting services using TradeLog to clients of GNM’s tax compliance service.

S-Corp tax breaks
S-Corps eligible for TTS provide opportunities for deducting retirement plan contributions and health insurance premiums, which sole-proprietor and partnership traders can’t use unless they have earned income.

See Entity Solutions, Retirement Plan Solutions, and Tax Planning For S-Corps.

SALT cap workaround
TCJA capped state and local income, sales, and property taxes (SALT) at $10,000 per year ($5,000 for married filing separately) and did not index it for inflation.

About 29 states have enacted SALT cap workaround laws. Generally, it would be best to elect to make a “pass-through entity” (PTE) payment on a partnership or S-Corp tax return filed by your business. This doesn’t work with a sole proprietorship filing a Schedule C.

PTE is a business expense deduction shown on the state K-1, like a withholding credit. Most states credit the individual’s state income tax liability with the PTE amount. Essentially, you convert a non-deductible SALT itemized deduction (over the cap) into a business expense deduction from gross income. 

Common errors

Reporting trading gains and losses on Schedule C
Some accountants intuitively think TTS traders should enter trading income, loss, and expenses on Schedule C like other sole proprietors. That’s wrong and often causes an IRS notice or exam.

Some traders try to deduct significant capital losses on Schedule C after missing the Section 475 MTM election deadline for ordinary gain or loss treatment. They attempt to evade wash sale (WS) loss adjustments and capital loss limitations.

Section 475 trades are detailed on Form 4797 Part II, ordinary gains and losses, not Schedule C.

Some traders use TTS and 475 when they should not.

SE tax errors
Some traders and preparers treat TTS trading gains as self-employment income (SEI) subject to self-employment (SE) tax. That’s incorrect unless the trader is a full-scale (dealer) member of an options or futures exchange and trading Section 1256 contracts on that exchange (Section 1402i).

Adjusted gross income (AGI) errors
Some TTS traders incorrectly contribute to a retirement plan based on trading income and end up with an “excessive contribution” subject to tax penalties. Trading income is unearned income, and contributions to retirement plans require earned income. 

Some mistakenly take an AGI deduction for self-employed health insurance premiums, which also requires SEI, and trading income is not SEI.

A TTS trader needs an S-Corp to arrange officer compensation for retirement and health insurance deductions before year-end.

Net investment tax errors
Trading gains and losses are included in net investment income (NII) when calculating the ACA’s 3.8% net investment tax (NIT).

Some traders do not deduct TTS trading expenses from NII, and you cannot deduct investment fees and costs from NII.

See IRS Form 8960 and Tax Center: ACA Net Investment Income Tax.

Proprietary traders
Proprietary traders significantly differ from retail traders and have special tax compliance needs. They don’t trade their capital. They trade the firm’s capital, usually accessed from a sub-trading account. A prop trader becomes associated with a prop-trading firm either as an LLC member (Schedule K-1), an independent contractor (1099-MISC), or an employee (W-2). See our tax center for tax strategies for prop traders. Click here.

Tax extensions

Individual 2023 income tax returns are due by April 15, 2024; however, most active traders aren’t ready to file a complete tax return by then.

Some brokers issue corrected 1099-Bs right up to the deadline and often after the filing deadline.

Many partnerships and S-Corps file extensions by March 15, 2024, and don’t issue final Schedule K-1s to investors until after April 15.

Traders don’t have to rush to complete their tax returns by April 15. They can use a simple one-page automatic extension and pay taxes owed to the IRS and state.

Tax payments are due with the extension
Traders can request an automatic six-month extension to file individual federal and state income tax returns until October 15, 2024.

The 2023 Form 4868 instructions indicate how easy it is to get this automatic extension; no reason is required.

It’s an extension to file a complete tax return, not an extension to pay taxes owed. Based on the tax information received, taxpayers should estimate and report what they think they owe for 2023.

Avoid late filing and late payment penalties
I suggest taxpayers learn how the IRS and states assess late-filing and late-payment penalties so they can avoid or reduce them. Interest expense of 8% applies to a balance due after April 15, 2024, too. Click here.

If taxpayers cannot pay the taxes owed, they should estimate the balance due by April 15 and report it on the extension.

Please make sure to file the automatic extension on time to avoid the late filing penalties, which are much higher than the late payment penalty.

Please look at 2023 Form 4868, page two, for an explanation of calculating these penalties.

See Tax Extensions: 12 Tips To Save You Money.

Read Green’s 2024 Trader Tax Guide and watch related webinar recordings for more information.

Traders Should Focus On Q4 Estimated Taxes Due January 16

January 2, 2024 | By: Robert A. Green, CPA | Read it on

Many traders have substantial trading gains for 2023, and they might owe 2023 estimated taxes paid to the IRS quarterly. Unlike employers, which withhold taxes on wages, brokerage firms do not withhold taxes on trading gains. Depending on their specific tax situation, other taxpayers may be able to wait to make tax payments until April 15, 2024, when they file their 2023 tax return or extension.

The first three quarterly estimated tax payments were due on April 18, June 15, and September 15, 2023; the fourth quarter payment is due on January 16, 2024. Many new traders didn’t submit estimated payments for the first three quarters, waiting to see what Q4 brought. Also, some traders view skipping estimated tax payments as a margin loan with interest rates of 7% for Q1 and Q2 2023 and 8% for Q3 and Q4 2023. With full transparency at year-end, traders can better assess the payment they should make for Q4 payments to minimize their underpayment penalties and interest.

The safe-harbor rule for paying estimated taxes says there’s no penalty for underpayment if the total payments made equal 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) exceeds $150,000 or $75,000 if you are single/married filing separately, then the safe-harbor rate rises to 110% of the previous year’s tax amount. 

Activity in Jan. 2024 can trigger wash sale losses for 2023, thereby creating more taxable income in 2023.

Suppose your 2022 tax liability was $40,000 and your AGI was over $150,000. Assume 2023 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 January 16, 2024, and paying the balance of $56,000 by April 15, 2024. This is a good option when compared to sending $90,000 in Q4 (90% of $100,000). Consider setting aside that tax money due on April 15, 2024, rather than risking it in the financial markets in Q1 2024. I’ve seen some traders lose the money they planned to use to pay taxes by trading it in the market. No money to pay your taxes causes trouble with the IRS. (See the example below.)

If your 2023 income tax liability is significantly lower than your 2022 tax liability, consider covering 90% of the current year’s taxes with estimated taxes. Check your state’s estimated tax rules, too.

In the above example, the trader should calculate the underpayment of estimated tax penalties for Q1, Q2, and Q3 on the 2023 Form 2210. Consider using Form 2210’s Annualized Income Installment Method if the trader generates most of his trading income later in the year. The default method on Form 2210 allocates the annual income to each quarter, respectively.

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

Here’s an example of what to avoid: Assume Joe Trader has massive capital gains taxes to pay for 2023. However, due to a market correction in early 2024 and being on the wrong side of many trades, Joe might incur significant capital losses in early 2024 in trading securities (equity options and equities). Unfortunately, Joe might lose much of the tax money he owes the IRS and state for 2023 taxes. Without an election, traders and investors will get stuck with a $3,000 capital loss limitation in 2024 and must carry over capital losses to subsequent years. However, Joe is eligible for trader tax status (TTS), so he submits a 2024 Section 475 election to the IRS by April 15, 2024, for ordinary gain or loss treatment with mark-to-market accounting to apply to his 2024 losses.

While this election won’t get back his tax money lost, the Section 475 election makes Joe’s 2024 trading losses “ordinary”; therefore, they will offset his other 2024 income, like wages and retirement plan distributions, thereby reducing 2024 taxes due. However, the 2017 TCJA legislation has an “excess business loss” (EBL) limitation in 2024 of $610,000 (married)/$305,000(other taxpayers). Business losses over the limit are considered EBL and become a net operating loss (NOL) carryforward, which offsets income of any kind in subsequent years. Unfortunately, TCJA doesn’t permit net operating loss (NOL) carrybacks for 2024. Before 2018, traders could carry back massive NOLs to replenish their trading capital and stay in business. The 2020 CARES Act suspended TCJA’s EBL and NOL changes for 2018, 2019, and 2020 and allowed five-year NOL carrybacks (i.e., a 2020 NOL carryback to 2015). TCJA’s EBL and NOL carryforward rules apply for tax years 2021 through 2028.

Traders and investors in futures contracts can consider a Section 1256 loss carryback election. Rather than use the 1256 loss in the current year, taxpayers may deduct 1256 losses on amended tax return filings, applied against Section 1256 gains only. It’s a three-year carryback; unused amounts carry forward. TCJA repealed most NOL carrybacks, so the 1256 loss carryback is a trader’s only remaining carryback opportunity.

Related webinar with recording on Jan. 10, 2024: Significant Tax Moves For Traders To Make in Q1 2024.

Star Johnson, CPA, contributed to this blog post.

 

 

Tax Planning For S-Corps

September 22, 2023 | By: Robert A. Green, CPA

Read our related blog post and watch the webinar, Tax Planning For Traders.

Traders eligible for trader tax status (TTS) use an S-Corp to unlock health, retirement, and SALT deductions. It’s important to act before year-end using payroll. 

S-CORP OFFICER COMPENSATION

TTS traders use an S-Corp to arrange health insurance and retirement plan deductions. These deductions require earned income or self-employment income. Unlike trading gains, which are unearned income, a TTS S-Corp salary is earned income.

S-Corps pay officer compensation in conjunction with employee benefit deductions through payroll tax compliance done before year-end 2023. Otherwise, traders miss the boat. TTS is necessary since an S-Corp investment company cannot have tax-deductible wages, health insurance, or retirement plan contributions. A trading S-Corp is not required to have “reasonable compensation,” so a TTS trader may determine officer compensation based on how much to reimburse for health insurance and how much they want to contribute to a retirement plan. Remember, sole proprietor and partnership TTS traders cannot pay salaries to 2% or more owners; hence, the S-Corp is needed.

S-Corp wages impact the SALT cap workaround, hinges on net income after wages. If you fall into the QBI phase-out range, wages are required to increase the QBI deduction. This decision-making has many moving levers, so consult your CPA for year-end tax planning in early December.

S-CORP HEALTH INSURANCE

S-Corps may only deduct health insurance for the months it was operational and qualified for TTS. Employer-provided health insurance, including Cobra, is not deductible.

The S-Corp reimburses the employee/owner through the accountable reimbursement plan before the end of the year. Add the health insurance reimbursement to taxable wages, but do not withhold social security or Medicare taxes from that portion of W-2 compensation. The officer/owner takes an AGI deduction for health insurance on their tax return.

A taxpayer can deduct a contribution to a health savings account (HSA) without TTS or earned income.

S-CORP RETIREMENT PLAN CONTRIBUTION

TTS S-Corps can unlock a retirement plan deduction by paying sufficient officer compensation in December 2023 when results for the year are evident. Net income after deducting wages and retirement contributions should be positive.

If you want to, you must establish a Solo 401(k) retirement plan for a TTS S-Corp with a financial intermediary before the year’s end. Plan to pay the 100%-deductible “elective deferral” amount up to a 2023 maximum of $22,500 (or $30,000 if age 50 or older with the $7,500 catch-up provision) with the December 2023 payroll. That elective deferral is due by the end of January 2024. You can fund the 25% profit-sharing plan (PSP) portion of the S-Corp Solo 401(k) up to a maximum of $43,500 by the 2023 S-Corp tax return due date, including an extension, which means September 15, 2024. The maximum PSP contribution requires wages of $174,000 ($43,500 divided by a 25% defined contribution rate). The maximum contribution for those under age 50 is $66,000 for 2023. For those 50 or older, it’s $73,500 for 2023. Tax planning calculations will show the projected outcome of the various options of income tax savings vs. payroll tax costs.

Consider a Solo 401(k) Roth for the elective-deferral portion only, where the contribution is not deductible, but the contribution and growth within the Roth are permanently tax-free. Traditional plans have a tax deduction upfront, and all distributions are subject to ordinary income taxes in retirement.

Traditional retirement plans have required minimum distributions (RMD) by age 73 in 2023, whereas Roth plans don’t have RMD. (See SECURE Act 2.0 RMD rules at https://www.irs.gov/retirement-plans/retirement-plan-and-ira-required-minimum-distributions-faqs.)

SALT CAP

TCJA capped state and local income, sales, and property taxes (SALT) at $10,000 per year ($5,000 for married filing separately) and did not index it for inflation. About 29 states enacted SALT cap workaround laws. Search “(Your state) SALT cap workaround” to learn the details for your state. Most states follow a blueprint approved by the IRS.

Generally, elect to make a “pass-through entity” (PTE) payment on a partnership or S-Corp tax return filed by your business. It doesn’t work with a sole proprietorship filing a Schedule C. PTE is a business expense deduction shown on the state K-1 like a withholding credit. Most states credit the individual’s state income tax liability with the PTE amount. Essentially, you convert a non-deductible SALT itemized deduction (over the cap) into a business expense deduction from gross income. Act well before year-end; otherwise, you might delay the benefit to next year.

HAVE YOUR NEW ENTITY READY ON JAN. 1, 2024

If you missed employee benefits (health insurance and retirement contributions) in 2023, consider an LLC with an S-Corp election for the tax year 2024. Or you may want a spousal-member LLC taxed as a partnership for 2024 to maximize the SALT cap workaround and segregate trading from investing.

If you want the new entity to be ready to trade on the first trading day of January 2024, consider the following plan. Form a single-member LLC in December 2023, obtain the employee identification number (EIN) online, and open the LLC brokerage account before year-end to be ready to trade as of Jan. 1, 2024. The single-member LLC is a “disregarded entity” for the tax year 2023, which avoids an entity tax return filing for the initial short year 2023. You can add your spouse as an LLC member on Jan. 1, 2024, creating a partnership tax return for 2024. 

If you want health insurance and retirement plan deductions for 2024, then your single-member or spousal-member LLC should submit a 2024 S-Corp election within 75 days of Jan. 1, 2024.

The partnership or S-Corp is a “new taxpayer” to make an internal resolution to elect Section 475 MTM on securities only for 2024 within 75 days of Jan. 1, 2024. Otherwise, existing partnerships or S-Corps must file an external 475 election statement with the IRS by March 15, 2024.

 

Tax Planning For Traders

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

Read our related blog post: Tax Planning For S-Corps.

Traders have unique needs and opportunities in tax planning. Get organized well before the year-end so you don’t miss out.

Recent tax acts don’t change trader tax status (TTS), Section 475 MTM accounting, wash-sale losses on securities, or the tax treatment on financial products, including futures (Section 1256 contracts) and cryptocurrencies (intangible property).

It’s helpful to consider IRS inflation adjustments in income and capital gains tax brackets, various income thresholds and caps, retirement plan contribution limits, standard deductions, and more. See the article, IRS Provides Tax Inflation Adjustments for Tax-year 2023. The IRS increase for 2023 is about 7%.

EXCESS BUSINESS LOSSES AND NET OPERATING LOSSES

TTS traders with a Section 475 election might incur ordinary business losses for 2023. Before the Tax Cuts and Jobs Act (TCJA) started in 2018, a TTS/475 trader could carry back a net operating loss (NOL) for two years, generating a tax refund. TCJA introduced an “excess business loss” (EBL) limitation, with the excess being an NOL carryforward. TCJA repealed NOL carrybacks (except for farmers) and limited NOL carryforwards to 80% of the subsequent year’s taxable income. CARES suspended TCJA’s EBL and NOL changes for 2018, 2019, and 2020 and allowed five-year NOL carrybacks (i.e., a 2020 NOL carryback to 2015). TCJA’s EBL and NOL carryforward rules apply for tax years 2021 through 2028.

DEFER INCOME AND ACCELERATE TAX DEDUCTIONS

Consider deferring income and accelerating tax deductions if you don’t expect your taxable income to decline in 2024.

Traders eligible for TTS in 2023 should consider accelerating trading business expenses, such as purchasing business equipment with first-year expensing using Section 179 or bonus depreciation.

Consider delaying sales of investments to defer capital gains. Defer bonuses at work. 

ACCELERATE INCOME AND DEFER CERTAIN DEDUCTIONS

A TTS trader with substantial Section 475 ordinary losses should consider accelerating income to soak up the EBL. Try to advance enough income to use the standard deduction and take advantage of lower tax brackets. Stay below the threshold for unlocking various AGI-dependent deductions and credits. A higher income can lead to an Income-Related Monthly Adjustment Amount (IRMAA) adjustment, raising Medicare premiums.

ROTH IRA CONVERSION

Consider changing a traditional IRA or 401(k) into a Roth IRA. Distributions from a standard retirement plan are taxed as ordinary income (not capital gains), whereas with a Roth IRA, distributions are tax-free.

On the conversion date, the market value of the traditional retirement account is income taxed at ordinary rates. Futures growth and capital in the Roth IRA account are tax-free. If your retirement portfolio is depressed, you might enjoy recovery of values inside a Roth IRA.

Generally, there’s a 10% excise tax on early withdrawals from retirement plans before age 59½. With a Roth IRA conversion, you can avoid excise tax by paying 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.

As an illustration, a taxpayer filing single has a $405,000 TTS/475 ordinary business loss. However, the excess business loss limitation for a single filing status in 2023 is $289,000 ($578,000 for married), so $116,000 is an NOL carryover. The taxpayer should consider a Roth conversion to soak up most of the $289,000 allowed business loss and leave enough income to use the standard deduction and lower tax brackets.

ZERO TAX RATE ON LONG-TERM CAPITAL GAINS IN THE LOWEST TAX BRACKET

If you have a low income, consider realizing long-term capital gains by selling open positions for over 12 months. The 2023 long-term capital gains rates are 0% for taxable income in the 10% and 12% ordinary tax brackets. The 15% capital gains rate applies to the regular middle brackets, and the top % capital gains rate of 20% applies to the top 37% ordinary income bracket. See capital gains tax brackets at https://taxfoundation.org/data/all/federal/2023-tax-brackets/. Remember, if you go $1 over the zero-rate bracket, all the long-term gains are subject to the 15% capital gains rate; it doesn’t work like progressive marginal ordinary tax brackets. 

NET INVESTMENT INCOME TAX

Investment fees and expenses are not deductible for calculating net investment income (NII) for the Affordable Care Act (ACA) 3.8% net investment tax (NIT). NIT only applies to individuals with NII and modified adjusted gross income (AGI) exceeding $200,000 single, $250,000 married filing jointly, or $125,000 married filing separately. The IRS does not index these ACA thresholds for inflation. NII includes portfolio income, capital gains, and Section 475 ordinary income and losses. 

BUSINESS EXPENSES AND ITEMIZED DEDUCTION VS. STANDARD DEDUCTION

Business expenses: TTS traders are entitled to business expenses and home-office deductions. The home office deduction requires income, except for the mortgage interest and real property tax portion. The SALT cap on state and local taxes does not apply to the home office deduction.

TCJA expanded first-year business property expensing; traders can deduct 100% of these costs in the year of acquisition, providing they place the item into service before year-end. Traders with TTS in 2023 may consider going on a shopping spree before Jan. 1. There is no sense in deferring TTS expenses because you cannot be sure you will qualify for TTS in 2024.

Employee business expenses: Ask your employer if they have an accountable plan for reimbursing employee-business costs. You must “use it or lose it” before the end of the year. TCJA suspended unreimbursed employee business expenses. TTS S-Corps should use an accountable plan to reimburse employee business expenses since the trader/owner is its employee.

Unreimbursed partnership expenses: 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 an S-Corp accountable plan because the partner can arrange the UPE after year-end. The IRS doesn’t want S-Corps to use UPE.

SALT cap: TCJA capped state and local income, sales, and property taxes (SALT) at $10,000 per year ($5,000 for married filing separately) and did not index it for inflation. About 29 states enacted SALT cap workaround laws. Search “(Your state) SALT cap workaround” to learn the details for your state. Most states follow a blueprint approved by the IRS.

Generally, elect to make a “pass-through entity” (PTE) payment on a partnership or S-Corp tax return filed by your business. It doesn’t work with a sole proprietorship filing a Schedule C. PTE is a business expense deduction shown on the state K-1 like a withholding credit. Most states credit the individual’s state income tax liability with the PTE amount. Essentially, you convert a non-deductible SALT itemized deduction (over the cap) into a business expense deduction from gross income. Act well before year-end; otherwise, you might delay the benefit to next year.

Investment fees and expenses: TCJA suspended all miscellaneous itemized deductions subject to the 2% floor, which includes investment fees and costs. TCJA left an itemized deduction for investment-interest expenses limited to investment income, with the excess as a carryover.

Standard deduction: TCJA roughly doubled the 2018 standard deduction and suspended and curtailed several itemized deductions. The standard deduction for married couples filing jointly for the tax year 2023 rises to $27,700, up $1,800 (about 7%) from $25,900 in 2022. For single and married individuals filing separately, the standard deduction rises to $13,850 for 2023, up $900 from $12,950 in 2022, and for heads of households, the standard deduction will be $20,800 for the tax year 2023, up $1,400 from $19,400 in 2022. (The IRS should publish the 2024 standard deduction amounts later in 2023.)

Many taxpayers use the standard deduction, simplifying their tax compliance work. For convenience, some taxpayers may feel inclined to stop tracking itemized deductions because they figure they will use the standard deduction. Don’t overlook the impact of these deductions on state tax filings, where you might get some tax relief.

ESTIMATED INCOME TAXES

Those who have reached the SALT cap don’t need to prepay 2023 state-estimated income taxes by Dec. 31, 2023 (a strategy before TCJA). Taxpayers should pay federal and state estimated taxes owed by Jan. 15, 2024, and the balance by April 15, 2024.

Many traders skip making quarterly estimated tax payments during the year, figuring they might incur trading losses later in the year. They can catch up with the Q4 estimate due by Jan. 15, 2024, but might still owe an underpayment penalty for Q1 through Q3 quarters. Some rely on the safe harbor exception to cover their prior year’s taxes. (See Traders Should Focus On Q4 Estimated Taxes Due Jan. 18.)

See Interest rates increase for the fourth quarter 2023. 

ADJUST WITHHOLDING ON YEAR-END PAYCHECKS

Employees should consider withholding additional taxes on year-end paychecks, which helps avoid underpayment penalties since the IRS treats wage withholding as being made throughout the year. This loophole applies to officers/owners of TTS S-Corps. 

AVOID YEAR-END WASH SALE LOSS ADJUSTMENTS

Taxpayers should report wash sale (WS) loss adjustments on securities based on “substantially identical” positions across all accounts, including IRAs. Substantially identical means equity, an option on that equity (equity option), and those options at different exercise dates. 

Conversely, brokers assess WS only on identical positions per the one account and report on the 1099-B for that account. Active securities traders should use a trade accounting program (i.e., TradeLog) to identify potential WS loss problems across all their accounts, especially going into year-end.

In taxable accounts, a trader can “break the chain” by selling the position before year-end and not repurchasing a substantially identical position 30 days before or after in any taxable or IRA accounts. Avoid WS between taxable and IRA accounts throughout the year, as that is a permanent WS loss.

Starting a new entity effective Jan. 1, 2024, can break the chain on individual account WS at year-end 2023, provided you don’t purposely avoid WS with the related party entity. The new entity can also elect Section 475 MTM.

WS losses might be preferable to capital loss carryovers at year-end 2023 for TTS traders. A Section 475 election in 2024 converts year-end 2023 WS losses on TTS positions (not investment positions) into ordinary losses in 2024. That’s better than a capital loss carryover into 2024, which might give you pause when making a 2024 Section 475 election. You want a clean slate with no remaining capital losses before electing Section 475 ordinary income and loss. (Learn how to read a broker 1099-B concerning wash sale loss adjustments in Green’s 2023 Trader Tax Guide Chapter 4.) 

TRADER TAX STATUS AND SECTION 475

Traders who qualified for TTS in 2023 may accelerate trading expenses into that qualification period as sole proprietors or entities. Those who don’t qualify until 2024 should try to defer trading expenses until then. Traders may also capitalize and amortize (expense) Section 195 startup costs and Section 248 organization costs in the new TTS business, going back six months before commencement. TTS is a prerequisite for electing and using Section 475 MTM.

TTS traders choose Section 475 on securities to be exempt from wash-sale loss rules and the $3,000 capital loss limitation and be eligible for the 20% QBI deduction. To make a 2023 Section 475 election, individual taxpayers had to file an election statement with the IRS by April 18, 2023 (March 15, 2023, for existing S-Corps and partnerships). If they filed that election statement on time, they must complete the election process by submitting a 2023 Form 3115 with their 2023 tax return. Those who missed the 2023 election deadline may want to consider the election for 2024. Capital loss carryovers are a concern — they can be used against capital gains but not Section 475 ordinary income. The 475 election remains in effect each year until it is revoked in the same manner as the election was made.

A Section 475 election made by April 18, 2024, takes effect on Jan. 1, 2024. When converting from the realization (cash) method to the mark-to-market (MTM) method, a Section 481(a) adjustment needs to be made on Jan. 1, 2024. The adjustment reports in 2024 taxable income the unrealized capital gains and losses on open TTS securities positions held on Dec. 31, 2023. The adjustment should not be made for year-end investment positions, and those who don’t qualify for TTS at year-end 2023 won’t have a Section 481(a) adjustment to report for the 2024 tax year.

A “new taxpayer” entity can elect Section 475 within 75 days of inception — a good option for those who missed the individual sole proprietor deadline (April 18, 2023). Forming a new entity on November 1, 2023, or later, is too late for establishing TTS for the 2023 year within the entity; we would like to see all of Q4 for entity TTS eligibility at a minimum. Consider waiting until Jan. 1, 2024, to start a new TTS entity and elect Section 475. 

20% DEDUCTION ON QUALIFIED BUSINESS INCOME

In 2018, TCJA introduced a 20% qualified business income deduction (QBI). In a simple scenario, on a QBI of $100,000, the owner might be able to deduct $20,000. That’s a tax deduction without spending any money.

Trading is a “specified service trade or business” (SSTB), which means an income cap applies. If your taxable income is over that cap, there is no QBI deduction. QBI includes Section 475 ordinary income, less TTS expenses, and excludes capital gains, portfolio income, and forex trading income.

Taxpayers can increase the QBI deduction with thoughtful year-end planning. Suppose taxable income falls within the phase-out range for a specified service activity or even above for a non-service business. You might need higher S-Corp wages (including officer compensation) to avoid a W-2 wage limitation on the QBI deduction. Deferring income can also help get under various QBI restrictions and thresholds. (Learn more about QBI in our tax guide, Chapters 2 and 7.) 

SUSPENDING TTS AND SECTION 475

Assume a TTS/475 trader stopped trading on June 30, 2023. They must use Section 475 through June 30, 2023, but may only use it for part of the year. TTS and 475 are “suspended” until and unless the trader is eligible again for TTS in a subsequent year. The trader can also revoke the 475 election for 2024 by April 15, 2024. Without 475 going into year-end, the trader should try to avoid wash sale loss adjustments at year-end.

TAX-LOSS HARVESTING

If you have an investment or trading portfolio, you can reduce capital gains taxes via “tax-loss harvesting” before the year’s end. If you realized significant capital gains year-to-date in 2023 and have open positions with substantial unrealized capital losses, consider selling some losing positions to reduce 2023 taxes on capital gains.

Be sure to wait 30 days to repurchase those securities to avoid wash sale loss adjustments, which would postpone the 2023 year-end tax loss to 2024, thereby defeating the concept of tax loss selling.

You don’t have to wait if you buy a similar security, providing it’s not “substantially identical.” For example, an exchange-traded fund (ETF) like SPY is substantially identical to options on SPY (the derivative) but not to other ETFs that track the S&P 500. The symbol SPX is a stock index future, a Section 1256 contract, which is not a security, so that’s okay to use to avoid wash sales.

TAX EFFICIENT SALES

If you want to sell some of your portfolios, consider taking long-term capital gains subject to lower tax rates (0%, 15%, and 20%) vs. short-term capital gains taxed at ordinary rates. That might require using the “specific identification accounting method” vs. first-in-first-out. (See FIFO vs. Specific Identification Accounting Methods.)

STRADDLES AND THE CONSTRUCTIVE SALE RULES

The IRS has rules to prevent the deferral of income and acceleration of losses in offsetting positions that lack sufficient economic risk. These rules include straddles, the constructive sale rule, and shorting against the box. Also, be aware of the “constructive receipt of income” — you cannot receive payment for services, turn your back on that income, and defer it to the next tax year.

Selling the losing legs on a complex options trade with offsetting positions can trigger the straddle loss deferral rules. 

CHARITABLE CONTRIBUTIONS

Consider a charitable remainder trust to bunch philanthropic contributions for itemizing deductions. 

You can also donate appreciated securities to charity if you don’t mind. You get a charitable deduction at the fair market value and avoid capital gains taxes. (This is a strategy billionaires use, which you can use.)

Consider directing your traditional retirement plan to make “qualified charitable distributions.” That satisfies the RMD rule, and it’s not taxable income. It’s the equivalent of an offsetting charitable deduction, allowing you to take the standard deduction rather than itemize charitable contributions.

In 2020 and 2021, the limit on charitable contributions increased to 100% of AGI. The limit reverts to the 50% limit for 2022 and subsequent years. (See the IRS site for Charitable Contribution Deductions.) 

TAX RELIEF: PRESIDENTIALLY DECLARED DISASTER AREAS

There have been several climate disasters in 2023, including hurricanes, wildfires, winter storms and floods. Check the irs.gov site for Tax Relief in Disaster Situations.

ChatGPT Explains Trader Tax Benefits

May 26, 2023 | By: Robert A. Green, CPA

I prompted Bing’s ChatGPT to write blog posts on “trader tax benefits” and “trader tax status.” See my comments in yellow highlight. I also used Grammarly. ChatGPT did a good job, but gave rudimentary advice. There are nuances in our content that ChatGPT missed. GreenTraderTax and my Forbes articles are a source for ChatGPT’s blog posts. 

Trader Tax Benefits:

If you are an active trader buying and selling securities for a living, you may wonder how to save money on taxes. One way to do that is to qualify for trader tax status (TTS), which allows you to deduct various business expenses and take advantage of unique tax treatments. This blog post will explain TTS, its benefits, and how to qualify.

What is trader tax status?

Trader tax status is a designation that the IRS grants to certain traders who meet specific criteria. It is not an election you can make; you must prove (assess) that you are eligible based on your trading activity and intention. Trader tax status allows you to treat your trading income and expenses as a business rather than an investor. You can deduct your trading-related expenses on Schedule C, such as commissions (wrong), software, education, interest, and home office. (Deduct brokerage commissions from sales proceeds and add them to cost basis when reporting capital gains and losses or Section 475 income.)

You can also elect to use Section 475 mark-to-market accounting, which converts your capital gains and losses into ordinary income and losses. Section 475 can help you avoid the wash sale rule and the $3,000 capital loss limitation. Additionally, if you form an LLC or a corporation and elect S-corp status, you can deduct health insurance premiums and retirement plan contributions as employee benefits.

How to qualify for trader tax status?

The IRS does not have a clear-cut definition of trader tax status, but it does provide some guidelines based on court cases and rulings. Generally, you must meet the following requirements:

– You trade substantially, regularly, frequently, and continuously throughout the year. You have to meet no specific number of trades or hours, but the IRS expects you to trade almost every day that the market is open and execute hundreds of transactions per year.

– You seek to profit from short-term price swings of securities rather than dividends, interest, or long-term appreciation. You typically hold your positions for less than a day or a few days at most (an average holding period of fewer than 31 days per the Endicott court is required).

– You intend to trade as a business, not as a hobby or a passive investment. You have a trading plan, a trading account separate from your (investment) account, and a dedicated workspace or office.

It would be best if you met these criteria consistently throughout the year. You may not qualify for trader tax status if you start or stop trading during the year or have significant gaps in your trading activity. (Part-year TTS qualification is okay.)

What are the benefits of trader tax status?

Trader tax status can provide significant tax savings for active traders. Here are some of the main benefits:

– You can deduct your trading expenses on Schedule C, reducing your adjusted gross income (AGI) and self-employment tax. These expenses include commissions (not brokerage commissions), software, subscriptions, education, interest, margin fees, and home office costs.

– You can elect Section 475 mark-to-market accounting, which allows you to report your trading gains and losses as ordinary income and losses on Form 4797. This way, you can avoid the wash sale rule, which disallows losses on (substantially identical) securities you buy back within 30 days (before or after). You can also fully deduct (within Excess Business Loss EBL and net operating loss NOL limitations) your trading losses against any income without being subject to the $3,000 capital loss limitation or the 3% (2%) AGI threshold for itemized deductions. (The 2017 Tax Cuts and Jobs Act TCJA suspended 2% miscellaneous itemized deductions from 2018 through 2025.)

– You can qualify for the 20% qualified business income (QBI) deduction if you have Section 475 income and your taxable income is below a certain threshold ($164,900 for single filers and $329,800 for married filing jointly in 2021). The QBI deduction reduces your taxable income by 20%, which lowers your effective tax rate.

– You can form an LLC or a corporation and elect S-corp status, which allows you to pay yourself a reasonable salary and deduct health insurance premiums and retirement plan contributions as employee benefits. These deductions also reduce your AGI and your self-employment tax.

Conclusion

Trader tax status is a valuable tax benefit for active traders who meet specific criteria. It allows you to deduct various business expenses and take advantage of unique tax treatments that lower your taxable income and tax liability. However, qualifying for trader tax status is tricky; you must (be ready to) prove (in an IRS exam) that you trade as a business with sufficient frequency, volume, and consistency. You must also comply with various rules and regulations regarding accounting methods, entity structures, and tax filings. Therefore, it is best to consult a professional trader tax advisor who can help you determine if you are eligible for trader tax status and how to maximize its benefits.

Trader Tax Status:

If you are an active trader who buys and sells securities for a living, you might be interested in trader tax status (TTS). (The intention of making a living is good enough). TTS is a special designation that allows you to deduct your trading expenses as business expenses and enjoy other tax benefits. However, only some people who trade qualify for TTS. You must meet certain criteria and follow specific rules to claim this status.

What are the benefits of trader tax status?

Trader tax status comes with several advantages, such as:

– You can deduct your trading-related expenses, such as margin interest, education, software, data feeds, subscriptions, home office, and more. These expenses are reported on Schedule C or the pass-through entity tax return, reducing your taxable income.

– You can elect Section 475 mark-to-market (MTM) accounting for your trading securities. You can treat your open positions as sold at fair market value on the last day of the year and report the unrealized gains or losses as ordinary income or loss. (Section 475 realized gains and losses are ordinary gains or losses, too.) This way, you can avoid the wash sale rules that defer losses on securities and the $3,000 capital loss limitation. Although this is uncertain, you might also qualify for the 20% qualified business income deduction on your Section 475 income.

– (Using an S-Corp), you can set up a retirement plan for yourself and your spouse (if applicable) and make tax-deductible contributions. A retirement plan can help you save for your future and lower your tax bill.

How do you qualify for trader tax status?

There is no election or application for trader tax status. It is based on your facts and circumstances and how you conduct your trading activity. The IRS needs to define TTS clearly, but it has provided some guidelines and court cases to help you determine eligibility.

According to the IRS, to qualify for trader tax status, you must:

– Trade substantially, regularly, frequently, and continuously. You need to meet no fixed number of trades or hours per day or week, but generally, the more trades and time you devote to trading, the better. A good rule of thumb is to average at least four daily transactions and 15 hours per week. (Green looks for a frequency of nearly four days a week with trade executions.)

– Seek to profit from short-term price swings of securities. It would be best if you did not hold securities for long-term appreciation or income. Your holding period should be less than 31 days on average.

– Have the intention to trade as a business. You should treat your trading activity as a serious and professional endeavor, not a hobby or a personal investment. You should have a separate trading account (or accounts), a dedicated workspace, a written trading plan, and proper records and reports.

How do you claim trader tax status?

If you meet the criteria for trader tax status, you can claim it on your tax return by reporting your trading expenses on Schedule C or the pass-through entity tax return. I would also like to ask you to please attach a statement explaining why you qualify for TTS and how you calculated your costs.

Suppose you want to elect Section 475 MTM accounting for your trading securities. In that case, you must file a timely election statement with the IRS by April 15 of the current year (or March 15 for partnerships and S corporations). You should also attach a copy of the election statement to your tax return. (New entities can elect Section 475 by internal resolution within 75 days of inception.)

If you want to set up a retirement plan for yourself and your spouse (if applicable), you must do so by December 31 of the current year. (A SEP IRA can wait until the tax return due date.) You can choose from various plans, such as a Solo 401(k), a SEP IRA, or a defined benefit plan. You should consult a tax professional to determine which plan is best for you and how much you can contribute.

Conclusion

Trader tax status is a valuable tax benefit for active traders who qualify. It allows you to deduct your trading expenses as business expenses and elect Section 475 MTM accounting for your trading securities. It also enables you to set up a retirement plan for yourself and your spouse (if applicable) and make tax-deductible contributions. (You need a TTS S-Corp to deduct a retirement plan and 2% owner health insurance premiums.)

However, trader tax status is not automatic or easy to obtain. You must meet certain criteria and follow specific rules to claim this status. You must also keep accurate records and reports of your trading activity and expenses. You should seek professional advice from a CPA or a tax attorney specializing in trader taxation before claiming TTS on your tax return.

 

Highlights From Green’s 2023 Trader Tax Guide

April 18, 2023 | By: Robert A. Green, CPA

Use Green’s 2023 Trader Tax Guide to receive the tax breaks you’re entitled to on your 2022 tax returns and execute tax strategies and elections for tax-year 2023. Our guide covers the impact of recent tax laws on traders.

BUSINESS TRADERS FARE BETTER

Investors have restricted investment interest expense deductions. The Tax Cuts & Jobs Act (TCJA) suspended investment fees and expenses for 2018 through 2025. Investors have a capital-loss limitation against ordinary income ($3,000 per year) and wash-sale (WS) loss adjustments, which can trigger capital gains taxes on phantom income. Investors benefit from lower long-term capital gains rates on positions held for 12 months or more before a sale (0%, 15%, and 20%). If traders have long-term investment positions, this is also available to them.

Traders eligible for trader tax status (TTS) are entitled to many tax advantages. A sole proprietor (individual) TTS trader deducts business expenses, startup costs, margin interest, and home-office expenses. TTS allows them to elect Section 475 MTM ordinary gain or loss treatment promptly. To deduct health insurance and retirement plan contributions, a TTS trader needs an S-Corp to create earned income with officer compensation. TTS traders use a pass-through entity (partnership or S-Corp) to arrange a state and local tax (SALT) cap workaround in many states.

TTS is different from the election of Section 475 MTM accounting. TTS is like an undergraduate university, and Section 475 is like graduate school. The 475 election converts new capital gains and losses into ordinary gains and losses, avoiding the $3,000 capital loss limitation. Only qualified business traders may use Section 475 MTM; investors may not. Section 475 trades are also exempt from WS loss adjustments. The 20% deduction on qualified business income (QBI) includes Section 475 ordinary income but excludes capital gains, interest, and dividend income.

A business trader can assess and claim TTS business expenses after year-end and even go back three open tax years. TTS does not require an election. But business traders may only use Section 475 MTM if they filed an election on time, either by April 18, for 2022 and 2023, or within 75 days of inception of a new taxpayer (i.e., a new entity). For more on TTS, see Chapter 1; for Section 475, see Chapter 2.

CAN TRADERS DEDUCT TRADING LOSSES?

Deducting trading losses depends on the instrument traded, the trader’s tax status, and various elections.

Many traders bought this guide, hoping to find a way to deduct their trading losses. Maybe they qualify for TTS, but that only gives them the right to take trading business expenses on Form 1040/Schedule C.

Securities, Section 1256 contracts, ETNs, and cryptocurrency trading receive default capital gain/loss treatment. Suppose a TTS trader did not file a Section 475 election on securities and commodities on time (i.e., by April 18, 2022) or have Section 475 from a prior year, they are stuck with capital loss treatment on securities and Section 1256 contracts. Section 475 does not apply to ETN prepaid forward contracts (not securities) or cryptocurrencies (intangible property).

Capital losses offset capital gains without limitation, whether short-term or long-term, but a net capital loss on Schedule D is limited to $3,000 per year against other income. Excess capital losses carry over to the subsequent tax year(s).

Once taxpayers get in the capital loss carryover trap, they often face a problem: how to use up the capital loss carryover in the following year(s). If a taxpayer elects Section 475 by April 18, 2023, the 2023 TTS trading gains will be ordinary rather than capital, thereby not utilizing the capital loss carryover. Once a trader has a capital loss carryover hole, they need a capital gains ladder to climb out of it and a Section 475 election to prevent digging an even bigger one. The IRS allows revocation of Section 475 elections if a Section 475 trader later decides they want capital gain/loss treatment again. Chapter 2 covers this topic in depth.

Traders with capital losses from Section 1256 contracts (such as futures) might be lucky if they had gains in Section 1256 contracts in the prior three tax years. On the top of Form 6781, traders can file a Section 1256 loss carryback election. This election allows taxpayers to offset their current-year net 1256 losses against prior-year net 1256 gains to receive a refund of taxes paid in prior years. TTS traders may elect Section 475 MTM on commodities, including Section 1256 contracts. Still, most elect it on securities only to retain the lower 60/40 capital gains tax rates on Section 1256 gains, where 60% is considered a long-term capital gain, even on day trades. The other 40% fall under ordinary income rates.

Taxpayers with losses trading forex contracts in the off-exchange Interbank market may be in luck. Section 988 for forex transactions receives ordinary gain or loss treatment by default, which means the capital-loss limitation doesn’t apply. However, the forex loss isn’t considered a business loss without TTS. It can’t be included in a net operating loss (NOL) carryforward calculation — potentially making it a wasted loss since it also can’t be added to the capital-loss carryover. If the taxpayer has another source of taxable income, the ordinary loss offsets it; the concern is when there is negative taxable income.

A TTS trader using Section 475 on securities has ordinary loss treatment, which avoids wash-sale loss adjustments and the $3,000 capital loss limitation. Section 475 ordinary losses offset income of any kind. However, Section 475 losses and TTS business expenses are subject to the excess business loss (EBL) limitation for tax years 2022 and 2023. Anything over the EBL threshold is a net operating loss (NOL) carryforward.

Those not using Section 475 must deal with wash-sale loss adjustments.

WASH-SALE LOSSES

Day and swing traders inevitably trigger many WS loss adjustments amounting to tens or hundreds of thousands of dollars. Create a WS loss when you take a loss on a security and repurchase it within 30 days (after or before).

A wash sale reduces the cost basis on the position sold and adds the WS loss to the replacement position’s cost basis, creating phantom taxable income and capital gains taxes.

It’s okay to incur WS losses during the year but try to avoid delaying the WS losses to the following year. Deferring a loss from November to December is acceptable; however, postponing a loss from December 2022 to January 2023 is not.

You can “break the WS chain” at year-end. For example, sell your entire position in security A by Dec. 20, 2022, and don’t repurchase it for 30 days — around Jan. 21, 2023. Waiting allows you to deduct the whole year of WS losses in 2022. See more about WS in Chapter 4.

EXCESS BUSINESS LOSS LIMITATION

In 2018, TCJA introduced an excess business loss (EBL) limitation. TCJA also repealed NOL carrybacks (except for farmers) and limited NOL carryforwards to 80% of the subsequent year’s taxable income. Add EBL over the threshold to the NOL carryforward.

The 2020 CARES Act suspended TCJA’s EBL, and NOL changes for 2018, 2019, and 2020 and allowed five-year NOL carrybacks (i.e., a 2020 NOL carryback to 2015). TCJA’s EBL and NOL carryforward rules apply for tax years 2021 through 2028.

See more about EBL and its thresholds in Chapter 2.

TAX TREATMENT ON FINANCIAL PRODUCTS

There are complexities in sorting through different tax-treatment rules and tax rates. It often takes work to tell what falls into each category. To help our readers with this, we cover the many trading instruments and their tax treatment in Chapter 3. Here’s a brief breakdown.

Securities have realized gain and loss treatment and are subject to WS rules and the $3,000 per year capital loss limitation on individual tax returns. Realization means income or loss when sold instead of mark-to-market (MTM) accounting. A Section 475 MTM election on securities avoids this issue.

Section 1256 contracts — including regulated futures contracts on U.S. commodities exchanges — are marked to market by default, so there are no wash-sale adjustments, and they receive lower 60/40 capital gains tax rates. Most TTS traders skip a Section 475 election on commodities to retain lower 60/40 capital gains rates.

Options have a wide range of tax treatments. An option is a derivative of an underlying financial instrument, and the tax treatment is generally the same. Equity options are taxed the same as equities, which are securities. Index options are derivatives of indexes, and broad-based indexes (stock index futures) are Section 1256 contracts. Simple and complex equity option trades have special tax rules on holding periods, adjustments, and more.

Forex receives ordinary gain or loss treatment on realized trades (including rollovers) unless a trader makes a contemporaneous capital gains election. In some cases, lower 60/40 capital gains tax rates on majors may apply under Section 1256(g).

Physical precious metals are collectibles; if a trader holds these capital assets for more than one year, sales are subject to the collectibles’ capital gains rate capped at 28%.

Cryptocurrencies are intangible property taxed like securities on Form 8949, but wash-sale loss and Section 475 rules do not apply because they are not securities.

Foreign futures are taxed like securities unless the IRS issues a revenue ruling allowing Section 1256 tax benefits.

ENTITIES FOR TRADERS

Entities can solidify TTS, unlock health insurance and retirement plan deductions, gain flexibility with a Section 475 election or revocation, prevent wash-sale losses with individual and IRA accounts, enhance a QBI deduction on Section 475 income less trading expenses, and provide a SALT cap workaround. An entity return consolidates trading activity on a pass-through tax return, making life easier for traders, accountants, and the IRS. Trading in an entity allows separation from individual investments.

An LLC with an S-Corp election is generally the best choice for a single or married couple seeking health insurance and retirement plan deductions.

A spousal-member LLC taxed as a partnership can segregate business trading from investments to perfect use of TTS and Section 475 and provide a SALT cap workaround, turning non-deductible state and local taxes as itemized deductions into tax-deductible business expenses. See Chapter 7.

RETIREMENT PLANS FOR TRADERS

TTS S-Corps can unlock a retirement plan deduction by paying sufficient officer compensation in December 2022 when results for the year are evident.

Consider a Solo 401(k) retirement plan with an elective deferral amount up to a maximum of $20,500 (or $27,000 if age 50 or older with the $6,500 catch-up provision). The Solo 401(k) also has a profit-sharing plan (PSP) up to a maximum of $40,500.

The IRS raised the 401(k) elective deferral for 2023 to $22,500 and the catch-up contribution to $7,500. See Chapter 8.

DEDUCTION ON QUALIFIED BUSINESS INCOME

In 2018, TCJA introduced a new tax deduction for pass-through businesses, including sole proprietors, partnerships, and S-Corps. Subject to haircuts and limitations, a pass-through business could be eligible for a 20% deduction on qualified business income (QBI).

Because TTS traders are considered a “specified service trade or business” (SSTB), taxable income above the following thresholds is not deductible: $340,100/$170,050 (married/other taxpayers) for 2022 and $364,200/$182,100 (married/other taxpayers) for 2023.

There is also a phase-out range above the threshold of $100,000/$50,000 (married/other taxpayers). The W-2 wage and property basis limitations apply within the phase-out range. TTS traders with an S-Corp usually have wages, whereas sole proprietor traders do not.

QBI for traders includes Section 475 ordinary income and loss and trading business expenses. QBI excludes capital gains and losses, Section 988 forex income or loss, dividends, and interest income.

For more information, see Chapter 7 and Chapter 17.

SALT CAP WORKAROUND

TCJA capped state and local income, sales, and property taxes (SALT) at $10,000 per year ($5,000 for married filing separately) and did not index it for inflation. About 29 states enacted SALT cap workaround laws.

Generally, elect to make a pass-through entity (PTE) payment on a partnership or S-Corp tax return filed by a business. It doesn’t work with a sole proprietorship filing a Schedule C. PTE is a business expense deduction shown on the state K-1 like a withholding credit. Most states credit the individual’s state income tax liability with the PTE amount. Essentially, convert a non-deductible SALT itemized deduction (over the cap) into a business expense deduction from gross income.

DESK REFERENCE

Some readers use our guide as a desk reference to quickly find answers to specific questions. Others read this guide in its entirety. To accommodate desk-reference readers, we edit each chapter to stand alone, which inevitably means some chapters contain information covered in others.

Table of Contents

Highlights. 

Chapter 1  Trader Tax Status.

Chapter 2  Section 475 MTM Accounting. 

Chapter 3   Tax Treatment of Financial Products. 

Chapter 4  Accounting for Trading Gains & Losses. 

Chapter 5   Trading Business Expenses.

Chapter 6  Trader Tax Return Reporting Strategies.

Chapter 7  Entity Solutions. 

Chapter 8  Retirement Plans.

Chapter 9  Tax Planning.

Chapter 10  Dealing with the IRS and States.

Chapter 11  Traders in Tax Court.

Chapter 12  Proprietary Trading. 

Chapter 13   Investment Management.

Chapter 14   International Tax. 

Chapter 15  ACA Net Investment Income Tax. 

Chapter 16   Short Selling. 

Chapter 17  Tax Cuts and Jobs Act.

Chapter 18  CARES Act.

 

Tax Extensions: 12 Tips To Save You Money

March 14, 2023 | By: Robert A. Green, CPA | Read it on

Individual tax returns for 2022 are due April 18, 2023. However, most active traders aren’t ready to file on time. Some brokers issue corrected 1099Bs right up to the deadline. Many partnerships and S-Corps file extensions by March 15, 2023, and don’t issue Schedule K-1s to partners until after April 18. Many securities traders struggle with accounting for wash sale loss adjustments.

The good news is that traders don’t have to rush the completion of their tax returns by April 18. They should take advantage of a simple one-page automatic extension with payment of taxes owed to the IRS and state. Most active traders file extensions, and it’s helpful to them on many fronts.

You might not have to file an extension if you are eligible for disaster tax relief. However, if you want to elect Section 475 MTM accounting for 2023, then consider filing an extension and attaching the election to that extension. (See Tax Relief In Disaster Situations.)

Tip 1: Get a six-month extension of time
By April 18, 2023, request an automatic six-month extension to file individual federal and state income tax returns due October 16, 2023. Form 4868 instructions indicate how easy it is to get this automatic extension, and the IRS doesn’t require a reason. It’s an extension to file a complete tax return, not an extension to pay taxes owed. Estimate and report what you think you owe for 2022 based on your tax information received.

Tip 2: Avoid penalties from the IRS and state for being late
Learn how IRS late-filing and late-payment penalties apply so you can avoid or reduce them to your satisfaction. 2022 Form 4868 (Application for Automatic Extension of Time To File U.S. Individual Income Tax Return) page two states:

The late payment penalty is usually 1⁄2 of 1% of any tax (other than estimated tax) not paid by the regular due date of your return, which is April 18, 2023. It’s charged for each month or part of a month the tax is unpaid. The maximum penalty is 25%.

The late payment penalty won’t be charged if you can show reasonable cause for not paying on time. Attach a statement to your return fully explaining the reason. Don’t attach the statement to Form 4868. You’re considered to have reasonable cause for the period covered by this automatic extension if both of the following requirements have been met. At least 90% of the total tax on your 2022 return is paid on or before the regular due date of your return through withholding, estimated tax payments, or payments made with Form 4868. The remaining balance is paid with your return.

A late filing penalty is usually charged if your return is filed after the due date (including extensions). The penalty is usually 5% of the amount due for each month or part of a month your return is late. The maximum penalty is 25%. If your return is more than 60 days late, the minimum penalty is $450 (adjusted for inflation) or the balance of the tax due on your return, whichever is smaller. You might not owe the penalty if you have a reasonable explanation for filing late. Attach a statement to your return fully explaining your reason for filing late. Don’t attach the statement to Form 4868.”

Check these types of penalties with your state, too. 

Tip 3: File an automatic extension even if you cannot pay
Even if you can’t pay what you estimate you owe, file the automatic extension form on time by April 18, 2023. It should help avoid the late-filing penalty, which is ten times more than the late-payment penalty. If you can’t pay in full, you should file your tax return or extension and pay as much as possible.

An example of late payment and late-filing penalties: Assume your 2022 tax liability estimate is $50,000. Suppose you file an extension by April 18, 2023, but cannot pay any of your tax balance due. You file your 2022 tax return on the extended due date of October 16, 2023, with full payment. A late-payment penalty applies because you did not pay 90% of your tax liability on April 18, 2023. The late-payment penalty is $1,500 (six months late x 0.5% per month x $50,000). Some traders view a late-payment penalty as a 6% margin loan, but it’s not tax-deductible.

By simply filing the extension on time in the above example, you avoided a late-filing penalty of $11,250 (six months late x 5% per month [25% maximum], less late-payment penalty factor of 2.5% = 22.5%; 22.5% x $50,000 = $11,250). The IRS also charges Interest on taxes paid after April 18, 2023.

If you don’t expect to owe 2022 taxes by April 18, 2023, it’s easy to prepare an extension with no balance due. Make sure to file it on time to avoid a minimum penalty if you were wrong and owe taxes for 2022.

Tip 4: Add a payment cushion for the first quarter (Q1) 2023 estimated taxes due
Traders with 2023 year-to-date trading gains and significant tax liability in the past year should consider making quarterly estimated tax payments in 2023 to avoid underestimated tax penalties. The IRS increased interest rates in 2022 and 2023, and current rates are 7% for underpayments. (See Interest rates increase for the first quarter of 2023.)

I recommend the following strategy for traders and business owners: Overpay your 2022 tax extension on April 18, 2023, and plan to apply an overpayment credit toward Q1 2023 estimated taxes. Most traders don’t make estimated tax payments until Q3 or Q4, when they have more precise trading results. Why pay estimated taxes for Q1 and Q2 if you incur substantial trading losses later in the year?

It’s better to pay an extra amount for the extension to set yourself up for three good choices: A cushion on 2022 if you underestimated your taxes, an overpayment credit toward 2023 taxes, or a tax refund for 2022 if no 2023 estimated taxes are due.

Tip 5: Consider a 2023 Section 475 MTM election
Traders eligible for trader tax status should consider attaching a 2023 Section 475 election statement to their 2022 federal tax return or extension due by April 18, 2023, for individuals and corporations and March 15, 2023, for partnerships and S-Corps.

Section 475 turns capital gains and losses into ordinary gains and losses, thereby avoiding the capital-loss limitation and wash-sale loss adjustments on securities (i.e., tax-loss insurance). Section 475 gains are eligible for the 20% qualified business income (QBI) deduction. (See How Traders Elect 475 To Maximize Their Tax Savings.)

Tip 6: File tax returns when it’s more convenient for you
Sophisticated and wealthy taxpayers know the “real” tax deadline is October 16, 2023, for individuals and September 15, 2023, for pass-through entities, including partnership and S-Corp tax returns. Pass-through entities file tax extensions by March 15, 2023.

Like most wealthy taxpayers, you don’t have to wait until the last few days of the extension period. Try to file your tax return in the summer months.

Tip 7: Be conservative with tax payments
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 wise for traders to apply overpayment credits toward estimated taxes owed on current-year trading income. You want to look like you will be successful in the current tax year.

The additional time helps build tax positions like qualification for trader tax status in 2022 and 2023. It may open opportunities for new ideas on tax savings. A rushed return does not.

Tip 8: Get more time to fund qualified retirement plans
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 2023 IRA contributions is April 18, 2023.

Tip 9: Respect the policies of your 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 the tax information received and estimates for missing data.

Your accountant begins your tax compliance (preparation) engagement, and they cut it off when seeing a solid draft to use for extension filing purposes. Your accountant will wait for the final tax information to arrive after April 18, 2023. 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 in a rush to file a complete tax return. Accounting firms with high-quality standards 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 at the last minute. That doesn’t serve anyone well.

Tip 10: Securities traders should focus on trade accounting
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. The capital loss carryover impacts your decision to elect Section 475 MTM for 2023 by April 18, 2023, but an estimate is sufficient.

Consider wash-sale loss rules on securities: If these adjustments don’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. (Consider TradeLog or GNM’s trade accounting service.) Try to do accounting work for year-to-date 2023; it also affects your decision-making on the 475 election.

Section 1256 contract traders can rely on the one-page 1099B showing aggregate profit or loss. Forex traders can depend on the broker’s online tax reports. Wash sales don’t apply to Section 1256 contracts and forex. Cryptocurrency traders should use crypto trade accounting programs to generate Form 8949.

Tip 11: Don’t overlook state extensions and PTE payments
Some states don’t require an automatic extension for overpaid personal tax returns; they accept the federal extension. You must file a state extension with payment if you owe state taxes. States tend to be less accommodating than the IRS in abating penalties, so covering your state taxes first is usually wise if you’re short on cash. Check the extension rules in your state.

For partnerships and S-Corps, don’t overlook pass-through entity (PTE) payments with the Form 7004 extension filing to benefit from the state’s SALT cap workaround solution enacted in about 29 states. (See Tax Tips For Traders Preparing 2022 Tax Returns.)

Tip 12: U.S. residents abroad should learn the particular rules
U.S. citizens or aliens residing overseas are allowed an automatic two-month extension until June 15, 2023, to file their tax return and pay any amount due without requesting an extension. (See Form 4868, page 2, “Taxpayers who are out of the country” and the IRS website.)

Darren Neuschwander, CPA, contributed to this blog post. 

 

 

Tax Relief In Disaster Situations

March 13, 2023 | By: Robert A. Green, CPA | Read it on

There have been many federal disaster situations around the U.S. these past years. See if you qualify to pay taxes and file tax returns after the original deadline.

See Tax Relief in Disaster Situations. For example IRS: May 15 tax deadline extended to Oct. 16 for disaster area taxpayers in California, Alabama and Georgia.

Check with your state(s) to see if they follow the IRS disaster relief —for example, More Time to File State Taxes for Californians Impacted by December and January Winter Storms.

Here’s content from Darren Neuschwander, CPA, Managing Member of Green, Neuschwander & Manning, LLC.

March 9, 2023: Due to the California storms, the IRS and CA Franchise Tax Board (FTB) released numerous press releases relating to the automatic filing extension. In plain English, this email is meant to clarify the extended deadlines as they stand now.

Affected taxpayers

Any taxpayer who resides in, or whose principal place of business is located in, any affected California county is granted an automatic extension of time to file and pay most federal and California tax obligations until October 16, 2023. These taxpayers do not have to be directly affected by the storms.

All counties in California are listed as affected counties except:

  • Imperial;
  • Kern;
  • Lassen;
  • Modoc;
  • Plumas;
  • Shasta; and
  • Sierra.

The extension deadline applies for federal and state tax filing/payment extension purposes if a county is listed in either IRS announcement (CA-2023-01 or CA-2023-02).

Returns

The automatic extension applies to the filing due dates for any of the following types of returns that have a due date (original or extended due date) on or after January 8, 2023, through October 16, 2023:

  • Individual income tax returns;
    •    Corporate income tax returns;
    •    Partnership income tax returns;
    •    Estate and trust income tax returns;
    •    Estate tax returns;
    •    Gift and generation-skipping transfer tax returns;
    •    Annual information returns of tax-exempt organizations;
    •    Payroll tax returns;
    •    Excise tax returns; and
    •    Employee benefit plan returns (Form 5500 series).

Payments

The automatic extension applies to any payments for the listed return types for payments due on or after January 8, 2023, through October 16, 2023, except for payroll tax deposits. The payment extension for payroll tax deposits only applied to deposits due from January 8, 2023, through January 23, 2023, and those deposits were due on January 23, 2023.

In other words, all payments for the above return types due on or after January 8, 2023, through October 16, 2023, are due on October 16, 2023, without incurring late payment penalties. This includes estimated tax payments and the California passthrough entity elective tax March 15, 2023, payment (for calendar-year taxpayers) as well as the June 15, 2023, prepayment for the 2023 tax year. Retirement plan contributions, including employer contributions, are extended to October 16, 2023.

Taxpayers can file their returns now and pay the tax later (although notices may still be sent).

The IRS press releases are available at:

www.irs.gov/newsroom/tax-relief-in-disaster-situations

California press releases are available at:

www.gov.ca.gov/2023/03/02/more-time-to-file-state-taxes-for-Californians-impacted-by-December-and-January-winter-storms/

The FTB’s extension-related FAQs are available at:

www.ftb.ca.gov/file/when-to-file/help-with-disaster-relief.html

A Section 475 MTM election for 2023
The above disaster relief might not apply to 2023 Section 475 MTM elections due on the original tax deadlines of 2022 tax returns. To play it safe, try to file the 2022 extension with the 2023 Section 475 election attached by April 18, 2023, for individuals and March 15, 2023, for partnerships and S-Corps.