Author Archives: Robert Green

Traders Should Consider Section 475 Election by the Tax Deadline

March 9, 2021 | By: Robert A. Green, CPA | Read it on

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

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

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Even though it’s too late to elect Section 475 MTM for tax-year 2020, the opportunity for 2021 is available now. In this blog post, I will cover the scenarios that make it prudent to obtain Section 475 for tax-year 2021 and how to make the election. 

Before I dive in, let’s review the deadlines, because they are approaching rapidly. Traders eligible for trader tax status (TTS) can elect 2021 Section 475 MTM on securities and/or commodities by April 15, 2021, for individuals and March 15, 2021, for partnerships and S-Corps. (The IRS postponed the April 15, 2021 tax deadline until June 15, 2021, for residents of Texas, Oklahoma, and Louisiana, after a federal disaster declaration in February 2021 due to winter storms. This postponement also applies to the Section 475 election. The delay includes various 2020 business returns due on March 15 like partnerships and S-Corps.)  

Why is Section 475 so attractive? It exempts securities trades from wash sale loss adjustments and the capital-loss limitation against other income; which is what I call “tax-loss insurance.” Profitable TTS/475 traders are eligible for the 20% qualified business income (QBI) deduction if under the QBI taxable income threshold (see below).

Who should make the Section 475 election? Capital gains are needed to absorb capital losses, so if you have capital loss carryovers or significant unrealized capital losses on segregated investment positions, the MTM election would be a gamble. If a TTS trader has new trading losses in 2021 YTD before the election deadline, then a 2021 Section 475 MTM election is generally preferred since it allows ordinary loss treatment and does not add to capital loss carryovers. 

Existing Individuals and Entities

To make the election, simply write this statement on a sheet of paper with your name and social security number (or entity EIN) up top. 

“Under IRC 475(f), the Taxpayer at this moment elects to adopt the mark-to-market method of accounting for the tax year ended December 31, 2021, and subsequent tax years. The election applies to the following trade or business: Trader in Securities as a sole proprietor (for securities and not Section 1256 contracts).” 

Attach the 475 election statement to your 2020 tax return or extension. (See Tips For Traders: Preparing 2020 Tax Returns, Extensions, and 475 Elections.) If you plan to e-file your 2020 tax return or extension, but cannot include the 475 election statement in the e-filing, then submit the 475 election statement with a cover letter to the IRS before the 2020 tax deadline. 

If you want to apply Section 475 to 1256 contracts, revise the statement to include commodities. (Generally, retaining lower 60/40 capital gains rates on 1256 contracts is the better choice.) 

The election statement is just the first part of the process — and the most crucial part. You also have to file a timely 2021 Form 3115 with your 2021 tax return in 2022 and fax a duplicative copy to the IRS. 

You can revoke a Section 475 election by the due dates in a mirror process. 

Section 475 MTM does not apply to duly segregated investment positions (more on that below).  

New Entities

The 475 election process is different for a new taxpayer, a newly formed entity, or first-time individual tax return filer. You must place the statement below in your books and records within 75 days of your new entity’s inception (new LLC/partnership or S-Corp). It’s safest to use the date you obtained the employer identification number (EIN).  

“Under IRC 475(f), the Taxpayer at this moment elects to adopt the mark-to-market method of accounting for the tax year ended December 31, 2021, and subsequent tax years. The election applies to the following trade or business: Trader in Securities as an entity (for securities only and not Section 1256 contracts).” 

A new taxpayer does not need to file a Form 3115 for an internal Section 475 MTM election. The new entity adopts the 475 MTM accounting method from inception. 

If you want to include Section 1256 contracts in the 475 election, then revise the election statement to include “commodities” (Section 1256 contracts). This action is wise if you have significant losses in the first 75 days in these contracts.

20% Deduction on Qualified Business Income

The Tax Cuts and Jobs Act of 2017 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). 

Traders eligible for TTS are considered a “specified service activity,” which means if their taxable income is above an income cap, they won’t receive a QBI deduction. The taxable income (TI) cap is $426,600/$213,300 (married/other taxpayers) for 2020, and $429,800/$214,900 (married/other taxpayers) for 2021. The phase-out range below the cap is $100,000/$50,000 (married/other taxpayers). The W-2 wage and property basis limitations also apply within the phase-out range. Investment managers are specified service activities, too. 

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

TCJA favors non-service businesses, which are not subject to an income cap. The W-2 wage and property basis limitations apply above the TI threshold of $326,600/$163,300 (married/other taxpayers) for 2020 and $329,800/$164,900 (married/other taxpayers) for 2021. The IRS adjusts the annual TI threshold for inflation each year. 

Sole proprietor TTS traders cannot pay themselves wages, so they likely cannot use the phase-out range, and the threshold is their cap. 

Segregation of Investments 

Suppose a trader holds investment positions in equities and trades substantially identical securities positions in equities or equity options using TTS and Section 475. The IRS could recharacterize trades as investments, or vice versa, whichever suits them best. For example, the IRS could reclassify an investment position in Apple equity currently deferred for long-term capital gains into Section 475 MTM ordinary income at year-end. Alternatively, the IRS could recharacterize Section 475 MTM ordinary losses on Apple options as capital losses triggering a $3,000 capital-loss limitation. 

Traders with overlap between investing and trading activity should consider ringfencing TTS/475 trading into an entity and conducting their investment activity on the individual level. That solution would fix the potential IRS problem. 

Here’s an example: Joe owns an investment portfolio of equities. He leverages his investments using portfolio margining to trade equity options around those investment positions to manage risk on the portfolio and collect option premium. Joe is not selling naked options because he holds equity investments and trades in the same brokerage account. Joe needs to choose between using Section 475 or portfolio margining. 

475 Fixes Wash Sales With IRAs For TTS Trades 

If there is an overlap in securities traded in taxable accounts vs. what’s invested in IRAs, the trader has to avoid triggering permanent wash-sale losses throughout the year. If a trader takes a loss in a taxable account and buys back a substantially identical securities position 30 days before or after in an IRA account, the loss becomes permanent. 

Traders can fix this problem with a “do not invest” list to avoid such overlap. One strategy is to trade equities and equity options in taxable accounts and invest in ETFs, mutual funds, and REITs in IRAs. 

TTS traders can make a Section 475 election to do away with wash sales between trades and the IRAs, so overlap is not a problem. 

Consider all IRA accounts for married filing joint, including traditional IRAs, Roth IRAs, rollover IRAs, and SEP IRAs. Don’t include qualified plans like 401(k) or solo 401(k) plans.

Most traders are not aware of the nuances of triggering permanent wash sales between taxable and IRA accounts. IRS rules for broker-issued 1099-Bs have a narrow view of wash sales; they call for wash-sale loss adjustments on “identical symbols” for the one account. Conversely, IRS wash sale rules for taxpayers have a broader view: Calculate wash sales on “substantially identical positions” (between equities and equity options) on all individual brokerage accounts, including IRAs. Consider using trade accounting software that’s compliant with IRS wash-sale rules for taxpayers. 

Examples

Joe Trader has a $100,000 Q1 2021 trading loss in securities, and he elects Section 475 by April 15, 2021, to offset the ordinary loss against wage income of $150,000. Without the election, Joe would have a $3,000 capital loss limitation against wages and a $97,000 capital loss carryover to 2022. Instead, he used his full trading loss in 2021. 

Nancy Trader has a $50,000 Q1 2021 trading gain and annual wages of $60,000. She might be eligible to receive a QBI deduction of $10,000 (20% x $50,000 QBI 475 net income). 

Section 475 is a consequential election for TTS traders with many advantages but consider your circumstances and the nuances first. We cover various Section 475 scenarios and more in-depth information on 475 elections in Green’s 2021 Trader Tax Guide (see Chapter 2 on MTM). 

Tips For Traders: Preparing 2020 Tax Returns, Extensions, and 475 Elections

March 1, 2021 | By: Robert A. Green, CPA | Read it on

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

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

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Traders use various tax forms as the IRS hasn’t created specialized tax forms for individual trading businesses. Traders enter gains and losses, portfolio income, and business expenses on different forms. It’s often confusing. Which form should forex traders use? Which form is correct for securities traders using the Section 475 MTM method? Can one report trading gains directly on a Schedule C? The different reporting strategies for various types of traders make tax time not so cut-and-dry.

Sole Proprietor Trading Business 

Trader tax status (TTS) constitutes business expense treatment and unlocks an assortment of meaningful tax benefits for active traders who qualify. The first step is to determine eligibility. Our golden rules require four trades per day, close to four days per week, and an average holding period under 31 days. See all the requirements at Trader Tax Status: How To Qualify.

If a trader qualifies for TTS, he can claim some tax breaks after the fact (such as business expense treatment) and elect and set up other benefits (such as Section 475 MTM and employee-benefit plans) on a timely basis. You can assess and claim TTS business expense deductions for all or part of 2020.

Other sole-proprietorship businesses report revenue, cost of goods sold, and expenses on Schedule C. But TTS business traders report only trading business expenses on Schedule C. Trading gains and losses are reported on various forms, depending on the situation. 

Trading Gains and Losses

Sales of securities must be first reported (line by line) on Form 8949 based on the realization method with cost basis adjustments, including wash sale (WS) losses. Form 8949 then feeds into Schedule D short-term capital gains using the ordinary tax rate and long-term capital gains for securities held 12 months using the lower capital gains rate. Capital losses offset capital gains in full, and net capital losses are limited to $3,000 per year against ordinary income (the rest is a capital loss carryover to subsequent years). 

Some brokers provide Form 8949 in addition to Form 1099-B. Consider using trade accounting software to calculate WS loss adjustments. See Form 8949 & 1099-B Issues.

TTS traders who use Section 475 MTM accounting on securities report their TTS trades (line by line) on Form 4797 Part II. “MTM” means open positions are marked-to-market at year-end. Form 4797 Part II has business ordinary loss treatment and avoids the capital loss limitation and wash-sale loss adjustments. Form 4797 losses are included in net operating loss (NOL) calculations. Consider using trade accounting software to generate Form 4797 for Section 475 trades. Without wash sale losses, the trader will be departing from the 1099-B and should explain that in a tax return footnote. 

Section 1256 contracts (i.e., regulated futures contracts) use MTM accounting and are reported on Form 6781 (unless the TTS trader elected Section 475 for commodities/futures; in that case Form 4797 is used). Section 1256 traders rely on a one-page Form 1099-B showing their net trading gain or loss (“aggregate profit or loss on contracts”). They may simply enter that amount in summary form on Form 6781 Part I. There are no wash-sale losses on 1256 contracts. 

Section 1256 contracts have lower 60/40 capital gains tax rates: 60% (including day trades) subject to lower long-term capital gains rates, and 40% taxed as short-term capital gains using the ordinary rate. At the maximum tax bracket for 2020, the blended 60/40 rate is 26.8% — 10.2% lower than the highest ordinary rate of 37%. See Section 1256 Contracts.

If the trader had a significant Section 1256 loss in 2020, she should consider carrying back those losses three tax years but only apply against Section 1256 gains in those years. To obtain this election, check box D labeled “Net section 1256 contracts loss election” on the top of Form 6781. You can make this election with a tax return filed on time, including extensions.

Forex traded in the Interbank market uses Section 988 ordinary gain or loss treatment. Forex traders who don’t qualify for TTS should use line 8 (other income or loss) on 2020 Schedule 1 (Form 1040).  TTS forex traders should use Form 4797, Part II ordinary gain or loss. What’s the difference? Form 4797 Part II losses contribute to NOL carryforwards against any type of income, whereas Form 1040’s “other losses” do not. The latter is wasted if the taxpayer has a negative income. 

In that case, a contemporaneous forex capital gains election is better on the Section 988 trades. If the taxpayer filed the Section 988 opt-out (capital gains) election, she should use Form 8949 for minor currencies and Form 6781 for major currencies. Forex uses summary reporting. See Forex.

Selling, exchanging, or using cryptocurrency triggers capital gains and losses. The IRS treats cryptocurrencies as intangible property. The realization method applies to short-term vs. long-term capital gains and losses, and there is no WS or 475 on intangible property. Report a capital gain or loss on each transaction, including cryptocurrency-to-currency sales, crypto-to-crypto trades, and purchases of goods or services using crypto. Answer the IRS question about cryptocurrency on the 2020 Form 1040 page 1 up top. 

For tax treatment on options, ETFs, ETNs, precious metals, foreign futures, and swaps, see Tax Treatment On Financial Products.

Business Expenses on Schedule C

TTS allows a trader to add a Schedule C to deduct business expenses, including these items:

  • “Tangible personal property” up to $2,500 per item for equipment and furniture.
  • Section 179 (100%) depreciation on fixed assets. Otherwise, bonus and regular depreciation.
  • Amortization of start-up costs (Section 195), organization costs (Section 248), and software.
  • Education expenses paid and courses taken after the commencement of TTS. Otherwise, pre-business education may not be deductible. (Alternatively, include pre-business education in Section 195 start-up costs.) 
  • Subscriptions, scanners, publications, market data, professional services, chat rooms, mentors, coaches, supplies, phone, travel, seminars, conferences, assistants, and consultants.
  • Home-office expenses for the business portion of the home.
  • Margin interest expenses.
  • Stock-borrow fees for short-sellers.
  • Internal-use software for self-created automated trading systems.

Home office (HO) expenses are first reported on Form 8829. HO is one of the most significant tax deductions for traders. It requires trading gains to unlock most of the deduction; mortgage interest and real estate tax portions of HO do not require income. 

When commencing TTS, look back six months to capitalize Section 195 start-up costs, including trading education expenses. The trader can expense (amortize) up to $5,000 in the first year and the balance over 15 years. 

Make Schedule C Look Better

The IRS may view a trading business’s Schedule C as unprofitable even if it has significant net trading gains on other forms and is profitable after expenses. 

To mitigate this red flag, transfer a portion of business trading gains to Schedule C “Other Income” (not revenue) to zero the expenses out but not show a net profit. Showing a profit could cause the IRS to inquire about self-employment (SE) tax on self-employment income (SEI). Trading expenses reduce SEI, but trading gains and losses are not SEI. Learn how to do this transfer strategy in Green’s 2021 Trader Tax Guide

Section 475 MTM Accounting

Only TTS traders can elect and use Section 475, not investors. Section 475 trades are exempt from WS loss adjustments on securities. Section 475 ordinary losses are also not subject to the $3,000 capital loss limitation against ordinary income. Section 475 losses and TTS expenses contribute to net operating losses (NOLs). Hence our phrase “tax loss insurance.”

We usually recommend a Section 475 election on securities only to retain lower 60/40 capital gains rates on Section 1256 contracts (commodities). 

Profitable traders might also benefit from Section 475. TCJA introduced a 20% deduction on qualified business income (QBI) in pass-through businesses, and TTS traders with 475 elections are eligible for the deduction. QBI includes Section 475 income less TTS expenses. However, QBI excludes capital gains and other portfolio income. TTS traders are a “specified service activity,” which means if their taxable income is above an income cap, they won’t receive a QBI deduction. The 2020 taxable income (TI) cap is $426,600/$213,300 (married/other taxpayers). The phase-out range below the cap is $100,000/$50,000 (married/other taxpayers). The W-2 wage and property basis limitations also apply within the phase-out range. Use Form 8995 or Form 8995-A for QBI deductions. 

Section 475 Election Procedures

To obtain Section 475 as an individual, you must file a 2021 Section 475 election statement with your 2020 tax return or extension due by April 15, 2021. Existing partnerships and S-Corps must file a Section 475 election statement by March 15, 2021. 

“New taxpayers” like new entities file an internal Section 475 MTM election resolution within 75 days of inception.

Traders who filed a 475 election for 2020 on time (by July 15, 2020, for individuals) must complete the process by sending a Form 3115 with the 2020 tax return and a duplicate to the national office. 

Learn more about Section 475, the pros, cons, and nuances in Green’s 2021 Trader Tax Guide. The guide includes the election statement to use with your filing. 

Tax Extensions

The 2020 income tax returns for individuals are due by April 15, 2021 — 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 or even beyond. Many partnerships and S-Corps file extensions by March 15, 2021, and don’t issue final Schedule K-1s to investors until after April 15. 

The excellent news is traders don’t have to rush the completion of their tax returns by April 15. They may want to consider sending a one-page automatic extension along with payment of taxes owed to the IRS and state.

The IRS postponed the April 15, 2021 tax deadline until June 15, 2021, for residents of Texas, Oklahoma, and Louisiana, after a federal disaster declaration in February 2021 due to winter storms. This postponement also applies to the Section 475 election. The delay includes various 2020 business returns due on March 15 like partnerships and S-Corps. 

Traders can request an automatic six-month extension on Form 4868 to file their federal income tax return by Oct. 15, 2021. States also provide tax extensions, with some states accepting the federal election; however, if the taxpayer owes state taxes, a state tax voucher/extension form is required. 

The Form 4868 instructions point out how easy it is to get this automatic extension — no reason is required. It’s an extension of time to file a complete tax return, not an extension of time to pay taxes owed. The taxpayer should estimate and report what he thinks he owes for 2020 based on his received tax information.

See how the IRS assesses late-filing penalties and late-payment penalties on page two of Form 4868. If a taxpayer cannot pay the taxes owed, he should estimate the balance due by April 15 and report it on the extension. 

Even if a taxpayer cannot pay the balance due, he should at least file Form 4868 by April 15, 2021. Merely filing the extension will avoid the late-filing penalties of 5% per month up to 25%, which are 10 times higher than the late-payment penalty of 0.5% per month up to 25%. The IRS charges interest, too. 

Many traders made massive trading gains in 2020 with an explosion of new pandemic-fueled traders and market volatility. Some used the estimated tax payment “safe harbor” exception to cover their 2019 tax liability with a Q4 2020 estimated tax payment made by Jan. 15, 2021. They plan to pay the balance of taxes owed by April 15, 2021. They should consider setting aside and protecting those tax payments. See Traders Should Focus On Q4 Estimated Taxes Due January 15.

Some traders will risk those 2020 tax payments in the markets right up to the deadline, and they should be careful not to lose them because that will cause significant tax trouble with the IRS and state. 

Partnerships and S-Corps

The 2020 partnership and S-Corp tax extensions are due March 15, 2021. They are easy to prepare since they pass income and loss to the owner, usually an individual. Generally, pass-through entities are tax-filers but not taxpayers.

S-Corps and partnerships use Form 7004 (Application for Automatic Extension of Time To File Certain Business Income Tax, Information, and Other Returns). Extensions give six additional months to file a federal tax return — by Sept. 15, 2021.

Your must file the partnership or S-Corp extension on time. Otherwise, late-filing penalties apply $210 per month per owner up to 12 months. See the Form 1065 and 1120S instructions for further details about penalties.  

Some states require a state extension, whereas others accept a federal extension. Some states have S-Corp franchise taxes, excise taxes, minimum taxes, and payments usually due to the extensions by March 15. LLCs filing as partnerships may have minimum taxes or annual reports due to the extension by March 15. States assess penalties and interest, often based on payments due.

Recent Tax Law Changes

The 2017 Tax Cuts And Jobs Act (TCJA) introduced an “excess business loss” limitation: $500,000 married and $250,000 other taxpayers for 2018, and it’s indexed for inflation each year. Business losses exceeding the EBL limitation are a NOL carryforward. TCJA also suspended NOL carrybacks, allowing NOL carryforwards with 80% limits against subsequent year’s taxable income. The rest carries forward indefinitely. 

The 2020 CARES Act provided temporary tax relief: It suspended TCJA’s EBL rules for 2018 through 2020 and allowed five-year NOL carrybacks for 2018, 2019, and 2020. TCJA EBL and NOL rules apply again in 2021. 

For other recent tax law changes that impact traders, see TCJA, CARES Act, and Emergency $900 Billion Pandemic Relief.

We expect tax legislation in 2021 that impacts traders, so stay tuned to our blog post for updates. 

Takeaway

Traders should focus on the big picture of filing a 2020 automatic extension by the April 15, 2021 deadline. With or without sufficient payment of taxes, filing the extension avoids the late-filing penalty of 5% per month, assessed on the tax balance due. Try to pay 90% of the tax liability to avoid the late-payment penalty of 0.5% per month. Traders unsure of TTS qualification can leave out Schedule C trading expenses from the tax liability calculations used for the extension filing and settle that issue before filing the complete tax return later. The most important issue might be a 2021 Section 475 election due with the 2020 extension by April 15, 2021, for individuals, and March 15, 2021, for partnerships and S-Corps. Overpaying the extension payment is wise for profitable traders to apply the overpayment credit towards 2021 quarterly estimated taxes. It also leaves a cushion on 2020 taxes.

 

Green’s 2021 Trader Tax Guide Available Now

January 27, 2021 | By: Robert A. Green, CPA

Green’s 2021 Trader Tax Guide is ready! Our 2021 guide covers the 2017 Tax Cuts and Jobs Act (TCJA) and the 2020 Coronavirus Aid, Relief, and Economic Security (CARES) Act’s impact on investors, traders, and investment managers.

Purchase the paperback version on Amazon here. Purchase the online version for immediate access here. Watch our Webinar covering the highlights of Green’s 2021 Trader Tax Guide here.

The highlights of this year’s guide are included below.

TAX CUTS AND JOBS ACT

Tax Cuts and Jobs Act (TCJA) was enacted on Dec. 22, 2017, and the law changes took effect in the 2018 tax year.

Like many small business owners, traders eligible for trader tax status (TTS) restructured their business to take advantage of TCJA. Two tax changes caught their eye: The 20% deduction on qualified business income (QBI) in pass-through entities, and suspended investment fees and expenses, which makes TTS even more crucial. (TCJA continues to allow itemized deductions for investment-interest expenses.) 

TCJA didn’t change trader tax matters, including business expense treatment, Section 475 MTM ordinary gain or loss treatment, and wash-sale loss adjustments on securities; it didn’t change TTS S-Corps’, Solo 401(k) retirement contributions and health-insurance deductions, either. TCJA also retains the lower Section 1256 60/40 capital gains tax rates; the Section 1256 loss carryback election; Section 988 forex ordinary gain or loss; and tax treatment on financial products including options, ETFs, ETNs, swaps, precious metals, and more.

CORONAVIRUS AID, RELIEF, AND ECONOMIC SECURITY ACT 

The 2020 Coronavirus Aid, Relief, and Economic Security Act (CARES) overrode TCJA’s limitations on tax losses. CARES suspended TCJA’s “excess business loss” limitation for 2018, 2019, and 2020. CARES also provided for five-year NOL carrybacks, whereas TCJA suspended NOL carrybacks. Traders with trader tax status and Section 475 ordinary loss treatment consider NOL carrybacks for 2018, 2019, and 2020. Learn more about CARES’ impact on traders in Chapter 18.

BUSINESS TRADERS FARE BETTER

By default, the IRS lumps all traders into “investor tax status,” and investors get penalized in the tax code — more so with TCJA. Investors have restricted investment interest expense deductions, and investment fees and expenses are suspended. Investors have capital-loss limitations against ordinary income ($3,000 per year), and wash-sale loss deferrals; they do not have the Section 475 MTM election option or health insurance and retirement plan deduction strategies. Investors benefit from lower long-term capital gains rates (0%, 15%, and 20%) on positions held for 12 months or more before sale. If active traders have segregated long-term investment positions, this is available to them as well.

Business traders eligible for TTS are entitled to many tax breaks. A sole proprietor (individual) TTS trader deducts business expenses, startup costs, and home office expenses, and is entitled to elect Section 475 MTM ordinary gain or loss treatment. However, to deduct health insurance and retirement plan contributions, a TTS trader needs an S-Corp to create earned income with officer compensation. 

Don’t confuse TTS with the related tax-treatment election of Section 475 MTM accounting. The 475 election converts new capital gains and losses into business 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 wash-sale loss adjustments. The 20% deduction on qualified business income includes Section 475 ordinary income but excludes capital gains, interest, and dividend income. The QBI deduction for TTS/475 traders is subject to a taxable income threshold and cap. 

A business trader can assess and claim TTS after year-end and even going back three open tax years. But business traders may only use Section 475 MTM if they filed an election on time, either by April 15 of the current year (July 15, 2020, for 2020, with three-month postponement under CARES) or within 75 days of inception of a new taxpayer (i.e., a new entity). For more on TTS, see Chapter 1.

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 2020 trading losses. Maybe they qualify for TTS, but that only gives them the right to deduct trading business expenses. 

Securities, Section 1256 contracts, ETNs, and cryptocurrency trading receive capital gain/loss treatment by default. If a TTS trader did not file a Section 475 election on securities and/or commodities on time (i.e., by July 15, 2020, or April 15, 2021, for 2021), or have Section 475 from a prior year, he is stuck with capital loss treatment on securities and Section 1256 contracts. Section 475 does not apply to ETN prepaid forward contracts, which are not securities, or cryptocurrencies, which are 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 are carried over to the subsequent tax year(s). 

Once taxpayers get in the capital loss carryover trap, a problem they often face is how to use up the carryover in the following year(s). If a taxpayer elects Section 475 by April 15, 2021, the 2021 TTS trading gains will be ordinary rather than capital. Remember, only capital gains can offset capital loss carryovers. That creates a predicament addressed in Chapter 2 on Section 475 MTM. Once a trader has a capital loss carryover hole, she needs 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 she wants capital gain/loss treatment again. 

Traders with capital losses from Section 1256 contracts (such as futures) may be in luck 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 allows taxpayers to offset their current-year losses against prior-year 1256 gains to receive a refund of taxes paid in prior years. Business traders may elect Section 475 MTM on Section 1256 contracts, but most elect it on securities only so they can 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. By default, Section 988 for forex transactions receives ordinary gain or loss treatment, which means the capital-loss limitation doesn’t apply. However, without TTS, the forex loss isn’t a business loss and therefore can’t be included in a net operating loss (NOL) 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 forex ordinary loss offsets it; the concern is when there is negative taxable income. Forex traders can file a contemporaneous “capital gains and losses” election in their books and records to opt out of Section 988, which is wise when capital loss carryovers exist. (Contemporaneous means in advance — not after the fact using hindsight.) In some cases, this election qualifies for Section 1256(g) lower 60/40 capital gains tax rates on major currency pairs.

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. 

The CARES Act allows taxpayers to submit five-year NOL carryback refund claims for the tax years 2018, 2019, and 2020 (i.e., a 2020 NOL carries back to 2015). Or taxpayers may choose to carry the NOL forward. TCJA tax-loss limitation provisions will apply again in 2021, allowing only NOL carryforwards used against 80% of the subsequent year’s taxable income. 

TCJA’s “excess business loss” (EBL) limitation also returns in 2021: $500,000 married and $250,000 other taxpayers (2018 limits). In 2021, taxpayers may add an EBL to a NOL carryforward. CARES suspended EBL rules for 2018, 2019, and 2020. See TCJA changes in Chapter 17 and CARES changes in Chapter 18.

TAX TREATMENT ON FINANCIAL PRODUCTS

There are complexities in sorting through different tax-treatment rules and tax rates. It’s often hard 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 wash-sale rules and the $3,000 per year capital loss limitation on individual tax returns. 

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. 

Options have a wide range of tax treatment. 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 period, adjustments, and more. 

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

Physical precious metals are collectibles; if these capital assets are held 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. 

Several brokerage firms classify options on exchange-traded notes (ETNs) and exchange-traded funds (ETFs) structured as publicly traded partnerships as “equity options” taxed as securities. There is substantial authority to treat these CBOE-listed options as “non-equity options” eligible for Section 1256 contract treatment. Volatility ETNs have special tax treatment: ETNs structured as prepaid forward contracts are not securities, whereas, ETNs structured as debt instruments are. 

Don’t solely rely on broker 1099-Bs: There are opportunities to switch to lower 60/40 tax capital gains rates in Section 1256, use Section 475 ordinary loss treatment if elected on time, and report wash-sale losses differently. Vital 2021 tax elections need to be made on time. See Chapter 3. 

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, and enhance a QBI deduction on Section 475 income less trading expenses. 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 individually held investments to be separate from business trading. It operates as a separate taxpayer yet is inexpensive and straightforward to set up and manage. 

An LLC with S-Corp election is generally the best choice for a single or married couple seeking health insurance and retirement plan deductions. See Chapter 7.

RETIREMENT PLANS FOR TRADERS 

Annual tax-deductible contributions up to $63,500 for 2020 and $64,500 for 2021 to a TTS S-Corp Solo 401(k) retirement plan generally save traders significantly more in income taxes when compared to the costs of payroll taxes (FICA and Medicare). Trading gains aren’t earned income, so traders use an S-Corp to pay officer compensation. 

There’s also an option for a Solo 401(k) Roth for the elective-deferral portion only: If you are willing to forgo the tax deduction, you’ll enjoy permanent tax-free status on contributions and growth within the plan. See Chapter 8. 

20% DEDUCTION ON QUALIFIED BUSINESS INCOME

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). 

Traders eligible for TTS are a “specified service activity,” which means if their taxable income is above an income cap, they won’t receive a QBI deduction. The taxable income (TI) cap is $426,600/$213,300 (married/other taxpayers) for 2020, and $429,800/$214,900 (married/other taxpayers) for 2021. The phase-out range below the cap is $100,000/$50,000 (married/other taxpayers). The W-2 wage and property basis limitations also apply within the phase-out range. Investment managers are specified service activities, too. 

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

TCJA favors non-service businesses, which are not subject to an income cap. The W-2 wage and property basis limitations apply above the TI threshold of $326,600/$163,300 (married/other taxpayers) for 2020, and $329,800/$164,900 (married/other taxpayers) for 2020. The IRS adjusts the annual TI threshold for inflation each year. 

Sole proprietor TTS traders cannot pay themselves wages, so they likely cannot use the phase-out range, and the threshold is their cap. For more information, see Chapter 7 and Chapter 17.

AFFORDABLE CARE ACT

TCJA and CARES did not change the Affordable Care Act’s (ACA) 3.8% Medicare tax on unearned income. The net investment tax (NIT) applies on net investment income (NII) for individual taxpayers with modified AGI over $250,000 (married) and $200,000 (single). The threshold is not indexed for inflation. Traders can reduce NIT by deducting TTS trading expenses, including salaries paid to them and their spouses. Traders may also reduce NII with investment expenses that are allowed on Schedule A, such as investment-interest expense. Investment fees and other investment expenses suspended from Schedule A also are not deductible for NII.

ACA’s individual health insurance mandate and shared responsibility fee for non-compliance, exchange subsidies, and premium tax credits continue to apply for 2020 and 2021. However, TCJA reduced the shared responsibility fee to $0 starting in 2019. 

For more information, see Chapter 9 and Chapter 15.

INVESTMENT MANAGEMENT CARRIED INTEREST

TCJA modified the carried interest tax break for investment managers in investment partnerships, lengthening their holding period on profit allocation of long-term capital gains (LTCG) from one year to three years. If the manager also invests capital in the partnership, she has LTCG on that interest after one year. The three-year rule only applies to the investment manager’s profit allocation — carried interest. Investors still have LTCG based on one year.

Investment partnerships include hedge funds, commodity pools, private equity funds, and real estate partnerships. Many hedge funds don’t hold securities for more than three years, whereas, private equity, real estate partnerships, and venture capital funds do.

Investors also benefit from carried interest in investment partnerships. TCJA suspended investment fees and expenses. Separately managed account investors are out of luck as investors pay investment fees, but hedge fund investors can limit the negative impact by using carried-interest tax breaks. The carried interest reduces a hedge fund investor’s capital gains instead of having a suspended incentive fee deduction.

INTERNATIONAL TAX MATTERS 

When it comes to global tax matters, we focus on the following types of traders: U.S. residents living abroad, U.S. residents with international investments, U.S. residents moving to U.S. territories like Puerto Rico (with substantial tax breaks), U.S. residents surrendering citizenship or green cards, and nonresident aliens investing in the U.S. with individual U.S. brokerage accounts or through an entity. See Chapter 14.

6 Items For Your Year-End Tax Shopping List

December 9, 2014 | By: Robert A. Green, CPA

Don’t let valuable tax deductions go down the drain. Attend our Dec. 11 webinar (or watch the recording) to discuss this content.

By Robert A. Green

Getting through your holiday “to-do” list — sending cards, gift buying, wrapping presents and baking cookies — is important for enjoying the holidays. The list may be long, but if you want gifts from Uncle Sam-ta, here are 6 items to add to it. Just be sure to execute them before year-end.

1. Make portfolio and business transactions for significant tax advantages.
Consider year-end transactions like selling winning or losing investment portfolio or business positions, invoicing clients and purchasing business items. If you are in the top tax bracket, defer income and accelerate expenses to reduce Obama-era tax hikes on income and net investment taxes (the combined federal tax rate is 44%). If you’re in lower tax brackets, accelerate income and defer expenses to utilize potentially wasted itemized deductions and take advantage of lower marginal tax brackets. A Roth IRA conversion is great for soaking up lower tax rates.  Learn more in our year-end tax planning blog and webinar.

2. Don’t get caught paying taxes on phantom income.  (Ouch! That would hurt.)
If you take a loss on a security toward year-end and buy back a substantially identical position in any of your taxable and/or IRA accounts within 30 days before or after, it’s considered a wash sale loss deferral (and permanently lost with an IRA). Break the chain on wash sales by not buying the position back in 30 days and get credit for the full tax loss in 2014.  Business traders should consider a Section 475 MTM election in 2015 to convert year-end wash sale losses on trading positions into business ordinary losses on Jan. 1. Turn garbage into gold!

3. You’ve set up your entity, but unless you execute compensation and employer 401(k) plans before year-end, its employee-benefit plan tax deductions will go down the drain.
Watch our video about how to use Paychex. It takes up to two weeks to sign up and execute compensation and an employer 401(k) plan, so get going today. If you want to save thousands of dollars with retirement plan and health insurance tax deductions (employee-benefit plans) for 2014, you must act on time. Plan to pay the 401(k) elective deferral portion by year-end. You can wait to fund the 25% profit-sharing plan through the due date of your 2014 tax return (including extension).

4. Don’t miss the boat on 2015; set up your trading business and entity for Jan. 2.
If you’ve been waiting to set up your trading business entity, starting on Jan. 2, 2015 is more convenient and beneficial. It breaks the chain on wash sales with your individual taxable and IRA accounts at year-end, since the entity is a different taxpayer identification number. 2015 tax compliance is easier and lower in cost, since you’ll report the entire year’s trading business activity on the entity return and skip individual tax compliance for part of the year in connection with trading activities.

It’s a little tricky to time the entity formation to a Jan. 2 start date. We can form a single-member LLC disregarded entity in December so you can execute the legal paper work and open the bank and trading accounts before year-end. We’ll add your spouse and or file the S-Corp election effective Jan. 1, 2015. As a disregarded entity in 2014, the SMLLC doesn’t force a partnership or S-Corp tax filing for 2014, even for a simple inactive entity tax return. However, in some states like California, we should wait until Jan. 2 to form the LLC, since that state charges a $800 minimum tax on LLCs even for just a few days in 2014. Consider our entity formation service.

5. Don’t get slapped with an underestimated tax payment penalty.
Get caught up with your 2014 estimated income taxes. Many traders underpay estimated taxes during the year, viewing the underestimated tax penalty as a low-cost margin loan. Why prepay taxes when you aren’t sure how the year will wind up? The Q4 estimate is due Jan. 15, 2015, so you can see where you stand at year-end first. Consider paying the state before year-end for another 2014 tax deduction, unless you trigger AMT and don’t get that benefit (state taxes are an AMT preference item).

6. The clock is ticking on RMDs, charitable contributions, gifts and FSAs.
Do your required minimum distributions (RMDs) from retirement plans, including Inheritor IRAs, and charitable contributions and gifts before year-end.  If you have a flexible spending account (FSA) with an employer, you must “use it or lose it” before year-end.

Contact us ASAP: We are standing by to help our clients with these transactions.

Happy holidays from all of us at Green NFH, LLC.

Adam Manning contributed to this blog.

 

11 Tax Breaks To Start And Grow A Small Business

November 10, 2014 | By: Robert A. Green, CPA

Join or watch our Webinar: 11 tax breaks to start and grow a small business.

Among the most popular “American dreams” is starting your own business. Entrepreneurship is the bedrock of America’s thriving economy and Congress continues to favor small business with tax breaks. Uncle Sam is patient for income taxes, allowing: upfront and accelerated expensing; paying business taxes on individual tax returns where other business or investment losses and expenses can be applied; lower tax rates (graduated rates) for lower income; and averaging business income over several years with net operating losses (NOLs). Plus America has voluntary tax compliance. America’s tax system is the envy of the world, and it’s the best place to start a business.

Interested in starting your own business? Find a niche in the marketplace in which you can compete with an edge. It’s possible to open a virtual business within weeks. The incredible advances in ecommerce have made it possible to launch a website with an online store and outsource fulfillment and logistics to other entrepreneurs. Borrow money at record low interest rates and get a full tax deduction for interest expense.

GreenTraderTax has been servicing investors, traders and investment managers since 1983. Business traders and investment managers are classic small businesses. Business traders have trading gains and losses rather than revenues. Investment managers have advisory fee revenues. Both have operating expenses and no inventory of products. They share many of the same tax, accounting, entity and retirement plan strategies and solutions.

Small business also generates self-employment income (SEI) or earned income, which in many cases triggers FICA and Medicare taxes — payroll taxes on wages or self-employment (SE) taxes on sole proprietor net income or Schedule K-1 ordinary income from partnerships. Traders do not have SEI on trading gains, with the exception of a futures trader who is a full-scale member of a futures exchange. S-Corps also do not pass through SEI, so the IRS requires “reasonable compensation” for officer/owners of approximately 50% of net income.

If you’re thinking of starting up your own small business, consider these 11 important tax breaks:

1.  Business expenses and NOLs

If you want to see what a country values most, study its tax code. In America, business enjoys the best tax breaks compared to investors and employees. Business expenses are deductible from gross income with few limitations and business losses comprise NOLs, which can be carried back two years and/or forward 20 years. You can choose between the cash or accrual method of accounting. Conversely, investment expenses and unreimbursed employee business expenses (Form 2106) are limited as miscellaneous itemized deductions on Schedule A.

Costs to develop, build or acquire a business or asset are capitalized as an asset. A taxpayer must check to see how the IRS allows expensing of that asset — depreciation or amortization —generally over a prescribed useful life. Obviously, the sooner you can write off an asset via a tax deduction, the more your net income will be reduced.

2.  First-year expensing (100% depreciation) and bonus depreciation

Section 179 “Election to expense certain depreciable business assets” allows 100% depreciation in the acquisition year on qualified Section 179 property. The 2013 limit was $500,000, but “tax extender” legislation lapsed at the end of 2013, so the old limit of $25,000 returns for 2014 with an adjustment for inflation. Hopefully, the 2014 and 2015 Congress will renew a much higher limit for Section 179 retroactively to Jan. 1, 2014. (Postscript on 12/4: —The House just renewed all tax extenders for 2014 and the Senate and White House will probably agree.) Learn more about the Section 179 Deduction on the IRS site, including What Property Qualifies?

3.  Start-up expenditures

Section 195 “start-up expenditures” include costs for “investigating and inquiring” about a new business; they do not include acquisition costs, fixed assets (equipment) or intangible assets (software). Sometimes a larger business may try to disguise acquisition costs as start-up costs and the IRS says no. However, many small business start-ups do have costs for investigating and inquiring about a new business. Business traders take classes before trading and that squeezes into start-up costs. Section 195 rules: file an internal “expense election” to deduct $5,000, plus deduct the rest over 180 months beginning with the month in which the business begins. Tip: start your business activity ASAP so expenses after commencement are unlimited operating expenses. We think capitalizing start-up costs six months from inception is reasonable.

4.  Organizational expenditures

Section 248 “organizational expenditures” are similar to start-up expenditures with an election for a $5,000 deduction and the rest over 180 months beginning with the first month. Organizational expenditures are for forming your business entity with attorneys, accountants and incorporation services. When an attorney provides various services to your company, it’s important to get an itemized breakdown of the fees between organization expenditures, operations, acquisition and personal.

5.  Converting personal expenses to business use

The majority of taxpayer individuals are employees receiving W-2s. Employees don’t have deductions from gross income or adjusted gross income (AGI). They are stuck with restricted itemized deductions for state and property taxes, mortgage and investment interest, charitable contributions and miscellaneous itemized deductions (investment expenses, tax compliance expenses and unreimbursed employee business expenses). Employees get few tax breaks after wasting deductions to thresholds, AMT preferences, the Pease limitation and state restrictions. It’s the opposite for small business: They get deductions from gross income (business and home-office expenses) and adjusted gross income (retirement and health insurance premiums).

Many small business people have an office in their home and they coop one of the family automobiles for business use too. They arrange vacations that can also accomplish some business goals like attending a trade show or convention. They socialize with other entrepreneurs who can help them succeed in their business. They start to blur the lines between business and personal and the end result is a reduction of personal non-deductible expenses and an increase of business expenses. Be sure to follow IRS rules on compliance, documentation, autos, travel and entertainment. It’s wonderful to convert personal-use assets and expenses into business-use assets, unlocking business deduction treatment. Without spending additional money, you convert limited itemized deductions or non-deduction of personal expenses into business tax deductions. Tip: Use GTT Tracker to track expenses and comply with IRS rules for documentation on a contemporaneous basis.

6.  Home-office deductions

The home-office deduction is one of the most powerful deductions for business owners. Since the IRS liberalized home office rules in 1999, taking the deduction is no longer a red flag. You don’t have to meet clients in your home, but you can only deduct home office expenses against business income. The amount not deducted is carried over to the subsequent tax year. Determine the home office percentage by either the square footage method or room’s method, and then deduct that percentage of all home expenses including depreciation or rent. Tip: Most taxpayers would love to write off a big chunk of their home expenses, so make sure you meet the exclusive use requirement to enjoy this juicy tax break.

7.  Retirement plan deductions

Uncle Sam gives generous tax breaks to those saving for retirement. All income growth in retirement plans is tax free until ordinary income distributions are taken in retirement. Set up officer compensation in your S-Corp or C-Corp or guaranteed payments in a partnership, or look to sole proprietorship net income. Establish a high-deductible retirement plan.

We generally recommend an employer 401(k) plan for corporations and partnerships and an Individual 401(k) plan for sole proprietors. The 401(k) elective deferral ($17,500 for 2014 and $18,000 for 2015) is 100% deductible, plus it’s paired with a 25% employer profit-sharing plan allowing a total contribution of up to $52,000 for 2014 and $53,000 for 2015. There’s also a catch-up contribution ($5,500 for 2014 and $6,000 for 2015) for taxpayers age 50 and over. An Individual 401(k) plan has a 20% profit sharing plan, which is not as generous as the employer plan.

High income businesses should consider a defined benefit (DB) plan where much higher amounts can be contributed per year (up to $210,000 for 2014). DB plans require actuaries and attorneys and it takes time to set up. Consider different options for your retirement plan contributions, and whether you have sufficient cash flow to maximize this tax deduction.

8.  Health insurance deductions

Sole proprietors and partners in partnerships have SEI which unlocks a 100% AGI deduction for health insurance premiums on their individual tax return. S-Corps are tricky: Add the individual health insurance of the officer to officer’s compensation and take a 100% AGI deduction for health insurance premiums on the owner’s individual tax return.

For high-deductible ACA-compliant health insurance plans, consider a Health Savings Account plan. If you have significant unreimbursed health expenses, consider a medical reimburse plan. Only a C-Corp can have an MRP, not a partnership or S-Corp for more than 2% owners and attribution rules apply to spouses. If you have a C-Corp, consider other types of fringe benefit plans, too.

9.  Hire family members

Shift income to children over the age of the kiddie tax rules. Hire a spouse to do the elective deferral for your spouse on an employer 401(k) plan.

10.  Active Investors

If you join a small business as an active investor — providing capital and labor — you can navigate around the onerous Section 469 passive-activity loss rules by meeting the material participation standards. Although material participation is similar to “trader tax status” requiring “regular, continuous and substantial” work, there are important differences. Material participation standards provide bright-line tests, whereas trader tax status looks to case law instead. The material participation rules are complex; read them closely and consult an expert afterward. (Read more about our creation of the “Active Investor” tax strategy on our blog Private-Equity Active Investor Tax Breaks.)

Passive investors may only deduct passive activity losses – passed through on Schedule K-1s – against passive activity income. They may not take a net loss in a given tax year, unless they sell the investment fully realizing the loss. Otherwise, they have suspended tax losses. Passive activity net income from pass-through entities is also subject to Obamacare 3.8% Medicare surtax on unearned income (Net Investment Tax, NIT bucket 2). Active investor owners don’t have net investment income for NIT.

11.  Ecommerce/virtual business in a tax-free state

Many taxpayers living in a high-tax state would like to operate their business from a tax-free state to avoid paying state taxes. If you operate a pass-through entity, it doesn’t make any sense since the income is passed to your individual state tax return anyway. To claim you do business in a foreign state rather than your resident state, you shouldn’t have employees, assets and sales in your resident state (known as “nexus” rules). Traders live, work and trade in their home state, so claiming an out-of-state business wouldn’t be feasible, and they use pass-through entities anyway. But it’s different for an ecommerce/virtual business set up in cyberspace.

One idea is to form a C-Corp in Delaware and operate an ecommerce/virtual business that is not landed with sales, employees, inventory or assets in your high-tax resident state. Arrange for the corporation to pay you fees as an agent (not employee). Those working in the corporation as independent contractors — along with the servers — must be located out of your home state.

Enjoy lower corporate tax rates of up to 15% on the first $50,000 of income and 25% on the next $25,000 of income. (The rate is 34% for $75,000 and up.) Avoid state corporate tax and individual tax for many years. After you accumulate large retained earnings, pay a qualifying dividend taxed at lower capital gains taxes up to 20% (federal plus state).

Be your own boss
Most Americans prefer the “security” of a job over the perceived risks of starting and owning your own small business. Putting in a week’s work and get a weekly paycheck seems safer than working hard at a new small business and perhaps losing money.

But many of today’s jobs are not your grandfather’s jobs which often provided a lifetime of pension security. Today’s jobs are more prone to disappear in a flash with outsourcing, mergers, reorganizations, downsizing, productivity improvements (machines taking over), company or product obsolescence and disruptive technologies. Corporate America has grown harsher in its never-ending pursuit of productivity and profit often at the expense of the people. To save a buck, established businesses boot out aging employees just as they reach the pinnacle of individual success and compensation. Starting your own small business is not just a dream — it’s good business.

When I left Ernst & Whiney (now big-four accounting firm Ernst & Young) in 1983 to start Green & Company CPAs, I felt more secure with five founding clients than just one employer. Losing one employer leaves you stranded, but losing one client may not be a problem at all. Entrepreneurs aren’t risk takers; they are risk avoiders. (Read my blog article Traders should think of themselves as entrepreneurs. Some may want to diversify by operating more than one business.)

Bottom line
Green & Company and Green NFH helped thousands of traders and others launch new businesses, and we are ready to help you too. We have the expertise you need to assess new business opportunities, structure the business with the right entity and employee-benefit plans, reap small business tax breaks and grow your business with success. What’s your small business American Dream?

MLPs Can Generate Tax Bills In Retirement Accounts

October 31, 2014 | By: Robert A. Green, CPA

Forbes

MLPs Can Generate Tax Bills In Retirement Accounts

It’s a surprise to many people that MLPs generate taxable income in retirement plans requiring a tax filing and payment of taxes.

Traders and investors are interested in using their IRA and other retirement plan accounts (collectively referred to as “retirement plans”) for making “alternative investments” in publicly traded Master Limited Partnerships (MLPs). Most MLPs conduct business in energy, pipelines, and natural resources. (Learn more about publicly traded partnerships at The National Association of Publicly Traded Partnerships, see its list of PTPs Currently Traded on U.S. Exchanges and read its warning about MLPs and Retirement Accounts.) Retirement plans also make alternative investments in hedge funds organized as domestic limited partnerships or offshore corporations.

Publicly traded partnerships (including MLPs) and hedge fund LPs use the partnership structure as opposed to a corporate structure. That allows organizers to pass through significant tax breaks on a Schedule K-1, including intangible drilling costs (IDC) and depreciation to individual investors. Taxes are paid on the investor/owner level, so the partnership structure avoids double taxation. Conversely, corporations owe taxes on the entity level and investor/owners pay taxes on dividends received from the corporation. (Real Estate Investment Trusts do not use a partnership structure.)

Tax problems for retirement plans investing in MLPs
Most MLPs conduct business activities including energy, pipelines and natural resources. But hedge funds do not — they buy and sell securities, futures, options and forex, which are considered portfolio income activities. Private equity and venture capital funds using the partnership structure also may pass through business activity income.

When retirement plans conduct or invest in a business activity, they must file separate tax forms to report Unrelated Business Income (UBI) and often owe Unrelated Business Income Tax (UBIT). MLPs issue Schedule K-1s reporting business income, expense and loss to retirement plan investor/owners. That’s the problem! The retirement plan then has UBI, and it may owe UBIT. Instead of the MLP being a tax-advantaged investment as advertised, it turns into a potential tax nightmare investment.

Form 990-T
According to Form 990-T and its instructions “Who Must File,” when a retirement plan has “gross income of $1,000 or more from a regularly conducted unrelated trade or business” it must file a Form 990-T (Exempt Organization Business Income Tax Return). While the retirement plan may deduct IDC and depreciation from net UBI, gross income will probably exceed $1,000 causing the need to file Form 990-T. UBIT tax brackets go up to 39.6%, which matches the top individual tax rate. (See the UBIT rates and brackets in the instructions.) File Form 990-T to report net UBI losses so there is a UBI loss carryforward to subsequent tax years.

Don’t overlook the need to file Form 990-T
Noncompliance with Form 990-T rules can lead to back taxes, penalties and interest. It can lead to “blowing up” a retirement plan, which means all assets are deemed ordinary income. And if the beneficiary is under age 59½, it’s considered an “early withdrawal,” subject to a 10% excise tax penalty. Schedule K-1s are complex, and UBI reporting can be confusing especially if the retirement plan receives several Schedule K-1s from different investments. Don’t look to brokers for help; most have passed off this problem to retirement plan trustees and beneficial owners (and that is you!).

In our July 2013 blog and Webinar “The DOs and DON’Ts of using IRAs and other retirement plans in trading activities and alternative investments,” we cautioned investors on making alternative investments in their retirement plan accounts. We talked about UBIT, self-dealing and prohibited transactions. We explained that U.S. pension funds invest in offshore hedge funds organized as corporations since the offshore corporations are “UBIT blockers.”

If your retirement plan is invested in a publicly traded partnership, assess your tax situation immediately, catch up with Form 990-T filing compliance and consider selling those investments. It’s better to buy them in a taxable account.

Unrelated Business Income Defined by the IRS site.

“For most organizations, an activity is an unrelated business (and subject to unrelated business income tax) if it meets three requirements:

  1. It is a trade or business,
  2. It is not substantially related to furthering the exempt purpose of the organization.

There are, however, a number of modifications, exclusions, and exceptions to the general definition of unrelated business income.”

Darren Neuschwander CPA and Star Johnson CPA contributed to this article. 

 


Obamacare Ushers In Several New Tax Forms For 2014

October 30, 2014 | By: Robert A. Green, CPA

The Patient Protection and Affordable Care Act (also known as Obamacare) enacted in 2012 has taken several years to implement and phase in. But now that the Obamacare 2014 individual health insurance mandate is in effect, many taxpayers will face confusion over tax penalties, exemptions, premium tax credits, claw backs of subsidies (advanced credits) and extra tax-preparation fees to comply with Obamacare on 2014 tax filings. In this post, I help clarify the details of the mandate.

There are three scenarios for dealing with the mandate on 2014 tax returns:

1.  Off-exchange coverage: If you had ACA-compliant health insurance coverage for all of 2014 — either an individual plan purchased directly from an insurance company (off exchange), an employer plan or government-sponsored programs like Medicare or Medicaid — there’s little to do. You may receive a new IRS Form 1095-B reporting your health insurance coverage from an insurance company and, if applicable, a Form 1095-C from your employer. Both of these tax forms are not mandatory for 2014. Give the 1095s to your accountant and you’re finished. There won’t be any penalties, premium tax credits or return of exchange subsidies.

2.  On-exchange coverage: If you purchased your 2014 health insurance on an exchange (marketplace), you will receive a mandatory Form 1095-A from the marketplace and you must file new tax Form 8962 (Premium Tax Credit).  When you applied for your 2014 health insurance coverage, you submitted estimates of your 2014 income which the exchange relied on for pricing your plan, perhaps offering a subsidized plan with “advanced credits.” The purpose of Form 8962 is to determine your rightful premium tax credit based on income reported on your 2014 tax return and to reconcile advanced credits (if any) with the premium tax credit calculated on Form 8962. Estimates probably won’t match actual income, especially for traders who have fluctuations in trading gains and losses.Therefore, one of three things will happen on Form 8962:

i.   You will have a tax liability caused by advanced credits being greater than the premium tax credit.

ii.  You will have a tax credit caused by advanced credits being less than the premium tax credit.

iii. No tax liability or credit because you used an exchange but did not receive an advanced credit and there is no premium tax credit.

The Obamacare Website says individuals can use an exchange even without getting a subsidized plan, but we heard from taxpayers that they were not permitted to use some state exchanges unless they qualified for subsidies. Some individuals say they received a better quote off exchange compared to on exchange without subsidies. Expect to receive new tax information document IRS Form 1095-A from the exchange reporting your coverage and any advanced credits paid for a subsidized plan. Give the 1095s to your accountant and he or she will prepare Form 8962. Tax software should have an input area to enter Form 1095 information and calculate Form 8962 and the premium tax credit.

3. No health insurance coverage: If you did not have ACA-compliant health insurance coverage for 2014 — and that includes large gaps in coverage — and you don’t qualify for an exemption from Obamacare, then you will owe a shared-responsibility payment (tax penalty). Apply to an exchange to receive a Form 8965 exemption for certain types of exemptions, and for others types of exemption claim them on a self-prepared Form 8965. As of Oct. 29, the IRS had not yet released a draft tax form for calculating the shared responsibility payment.

The shared responsibility payment is whichever amount is larger of the following: For 2014, the payment is either $95 per adult and $47.50 per child (up to $285 for a family) or 1% of household income. For 2015, it’s either $325 per adult and $162.50 per child (up to $975 for a family) or 2% of household income. For 2016, it’s either $695 per adult and $347.50 per child (up to $2,085 for a family) or 2.5% of household income. Per the IRS Website, “the individual shared responsibility payment is capped at the cost of the national average premium for the bronze level health plan available through the Marketplace in 2014.” As has been widely publicized, the shared responsibility payment is not enforceable by the IRS. That means the IRS will offset the payment against tax refunds due, but it can’t file liens, levy assets or start collection proceedings for this payment. The IRS may fully enforce claw-backs of advanced credits (subsidies) reported on Form 8962.

The 2014 Form 1040 has three lines dealing with the Obamacare health insurance mandate:

  1. Tax (line 46): Excess advance premium tax credit repayment. Attach Form 8962.
  2. Payment (line 69): Net premium tax credit. Attach Form 8962.
  3. Other Taxes (line 61): Health care: individual responsibility (see instructions). Full-year coverage (box to check).

Open enrollment through exchanges for 2015 coverage
Traders should consider special strategies for purchasing 2015 health insurance coverage through exchanges. The open enrollment period runs from Nov. 15, 2014 to Feb. 15, 2015. Most individuals will purchase 2015 insurance before they deal with Obamacare tax compliance on 2014 tax returns.

If you want to receive a premium tax credit on Form 8962, you need to enroll through an exchange, not directly with an insurance provider or employer. You can’t receive premium tax credit if you are eligible for other “minimum essential coverage,” such as employer-sponsored coverage that’s considered adequate and affordable. Traders should use a reasonable basis for providing the exchange with an estimate of household income perhaps qualifying for a subsidized plan with advanced credits. Some exchanges ask for monthly household income for either 2014 or 2015. Remember, you will have to square up with the IRS on a 2015 Form 8962 but at least you’re in the game for filing a Form 8962 and receiving a premium tax credit. Many traders may have low income in 2015 and they should keep this opportunity open. High-income sole proprietors have confidence they won’t get a premium tax credit and they can skip the exchange all together if working directly with an insurance provider is more convenient.

The exchange system is inconvenient for traders who have fluctuating income
Most individuals consider ACA-compliant non-subsidized health insurance plans expensive. If your household income is above 400% of the Federal Poverty Line, you or your family won’t qualify for a subsidized plan on the exchange. You may even face obstacles in using an exchange. No worries, you can purchase an individual or employer ACA-compliant health insurance plan directly through an insurance company. Just keep in mind that rules out the possibility of getting a premium tax credit if you wind up with household income under 400% of the Federal Poverty Line since the insurance must be purchased through an exchange to qualify for the credit.

Many traders have wide fluctuations in trading gains and losses from year-to-year. They could easily fall under 400% of the Federal Poverty Line in 2014 and qualify for an exchange-subsidized plan for the year of 2015. But these traders may wind up with large trading gains in 2015, thereby triggering an “excess advance premium tax credit repayment” (claw back of subsidies) on their 2015 Form 8962. The big problem is the exchange requires an estimate of income before the coverage year starts, and traders don’t know their income until the year ends. Tip: Traders can use an exchange but decline the subsidies up front and file for a premium tax credit if their income is under 400% of the federal poverty line.

There are five new Obamacare tax forms for 2014

1.  Form 1095-A: Health Insurance Marketplace Statement. The exchange issues this form to individuals who purchased insurance through an exchange for 2014. (Similar to a bank or broker that issues a tax information Form 1099.) Its instructions state: “You received this Form 1095-A because you or a family member enrolled in health insurance coverage through the Health Insurance Marketplace. This Form 1095-A provides information you need to complete Form 8962, Premium Tax Credit (PTC). You must complete Form 8962 and file it with your tax return if you want to claim the premium tax credit or if you received premium assistance through advance credit payments (whether or not you otherwise are required to file a tax return). The Marketplace has also reported this information to the IRS. If you or your family members enrolled at the Marketplace in more than one qualified health plan policy, you will receive a Form 1095-A for each policy.”  If the Form 1095-A does not list any advanced credits and you are confident your income will be well above 400% of the Federal Poverty Line, you don’t have to prepare Form 8962.  Some taxpayers may easily generate the form with their tax software and choose to attach it with their return just in case IRS computers look for it.

2.  Form 1095-B: Health Coverage. The insurance provider issues this form to individuals, although it’s not mandatory for 2014. Its instructions state: “This Form 1095-B provides information needed to report on your income tax return that you, your spouse and individuals you claim as dependents had qualifying health coverage (referred to as “minimum essential coverage”) for some or all months during the year. Individuals who do not have minimum essential coverage and do not qualify for an exemption may be liable for the individual shared responsibility payment. Minimum essential coverage includes government-sponsored programs, eligible employer-sponsored plans, individual market plans and miscellaneous coverage designated by the Department of Health and Human Services. For more information on minimum essential coverage, see Pub. 974, Premium Tax Credit (PTC).”

3. Form 1095-C: Employer-Provided Health Insurance Offer and Coverage. The employer issues this form to individuals, although it’s not mandatory for 2014. Its instructions state: “This Form 1095-C includes information about the health coverage offered to you by your employer. Form 1095-C, Part II, includes information about the coverage, if any, your employer offered to you and your spouse and dependent(s). If you purchased health insurance coverage through the Health Insurance Marketplace and wish to claim the premium tax credit, this information will assist you in determining whether you are eligible. For more information about the premium tax credit, see Pub. 974, Premium Tax Credit (PTC).” Some people used an exchange to receive subsidies even though their employer offered them a good health insurance plan as reported on Form 1095-C, so these individuals should be prepared for a claw back of subsidies on Form 8962.

4. Form 8962: Premium Tax Credit.  This tax form is prepared by taxpayers and/or their tax preparers. Its instructions state: “Complete Form 8962 only for health insurance coverage in a qualified health plan (described later) purchased through a Health Insurance Marketplace (also known as an exchange). This includes a qualified health plan purchased on www.healthcare.gov.” Caution: An “excess advance premium tax credit repayment” increases estimated income taxes due, whereas a “net premium tax credit” (payment) does not reduce estimated taxes due since payments are listed below tax liability. (That’s inconsistent and unfair in our view.)

The Federal Poverty Line and household income
Exchange subsidies and the Form 8962 premium tax credit are granted to individuals and families with household incomes between 100% and 400% of the “Federal Poverty Line.” Household income is also used for calculating the Obamacare shared responsibility payment for not having minimum essential coverage or an exemption from coverage (Form 8965). Household income is basically taxpayer’s adjusted gross income reported on the tax return plus: Social Security payments excluded from AGI, tax-exempt income (i.e. municipal bond interest), and Form 2555 exclusions for U.S. residents abroad (foreign earned income and housing allowance). Household income also includes the income of any dependents covered on the family insurance plan.

Tax planning tip: Try to defer income and accelerate losses and expenses for household income so you don’t go just a few dollars over 400% of the federal poverty line, as that would require a 100% claw-back of exchange subsidies on Form 8962.

An Obamacare website https://www.healthcare.gov/income-and-household-information/income/ confirms household income includes “Social Security payments, including disability payments — but not Supplemental Security Income (SSI).” According to Form 8962 instructions, social security benefits otherwise not subject to income tax are “added back” since you start with modified AGI rather than just AGI. Eighty-five percent of Social Security payments are included in AGI if the taxpayer exceeds the Social Security AGI threshold of $44,000 for married filing joint ($34,000 for all other taxpayers). Taxpayers under those thresholds exclude 100% of Social Security payments from AGI. Including all social security payments in household income pushes many seniors above the Federal Poverty Line and prevents them from getting a premium tax credit, but most seniors don’t use the exchange because they are covered under Medicare.

For a full description of household income, see Form 8962 instructions.

Federal Poverty Line Chart
(based on Form 8962 instructions; these numbers are slightly different for Hawaii and Alaska residents)

Family 100% of
Federal Poverty
400% of Federal
Size Line Poverty Line
1            11,490             45,960
2            15,510             62,040
3            19,530             78,120
4            23,550             94,200
5            27,570           110,280
6            31,590           126,360
7            35,610           142,440
8            39,630           158,520

5.  Form 8965: Health Coverage Exemptions and instructions. A state or federal exchange needs to issue Form 8965 for certain types of exemptions (like religious), and for other types of exemptions (such as a short coverage gap) the taxpayer may self-prepare the Form 8965. (Be diligent to apply to the appropriate exchange on time — exchanges won’t contact you first.) Taxpayers without a Form 8965 exemption or minimum essential coverage are subject to a shared responsibility payment (see above). For one-page summaries of the exemptions available, see http://www.irs.gov/uac/ACA-Individual-Shared-Responsibility-Provision-Exemptions or IRS Publication 5172 – Facts about Health Coverage Exemptions.

According to Obamacare Mandate: Exemption and Tax Penalty, “The mandate’s exemptions cover a variety of people, including: members of certain religious groups and Native American tribes; undocumented immigrants (who are not eligible for health insurance subsidies under the law); incarcerated individuals; people whose incomes are so low they don’t have to file taxes (currently $9,500 for individuals and $19,000 for married couples); and people for whom health insurance is considered unaffordable (where insurance premiums after employer contributions and federal subsidies exceed 8% of family/household income); and those going without insurance for less than three months in a row … Hardship Exemption Update: If you had your plan canceled in 2014 due to the Affordable Care Act you now qualify for a hardship exemption in 2014. That means you won’t have to pay the shared responsibility payment if you decide to go without insurance and will qualify for low premium, high out-of-pocket catastrophic plans on your state’s health insurance marketplace.” U.S. residents abroad who qualify for Section 911 (foreign earned income exclusion) are deemed to have minimum essential coverage whether they do or not. That means they don’t apply for a Form 8965.

Obamacare is progressive taxation
Obamacare is the epitome of progressive taxation and transfer payments using fiscal policy. Upper-income taxpayers pay more to subsidize lower-income folks, and middle-class taxpayers pay their fair share of more expensive coverage that can’t rider out pre-existing conditions. Like many new major social programs enacted before it, some Obamacare tax hikes started on upper-income taxpayers before the new benefits were even provided, including Obamacare Net Investment Income Tax, which started in 2013 even though Obamacare benefits didn’t start until 2014. (Read more about Net Investment Income Tax reported on Form 8960.)

Open question: Are federal exchange subsidies legal?
One court ruled that federal exchange subsidies are illegal and another court overruled it. The Supreme Court agreed to hear the case (WSJ Nov. 7). Obamacare law authorizes subsidies “through an exchange established by the state,” it does not mention a federal exchange. Obamacare law contemplated that all states would have a state exchange but many states balked and chose to participate in HealthCare.gov, the federal exchange just as some also balked at Obamacare’s Medicaid expansion. Did Obamacare purposely provide an incentive to states to create their own exchange, or was leaving out subsidies for the federal exchange an inadvertent oversight? (Read more: http://www.cnbc.com/id/102137279 and http://www.cnbc.com/id/102147639.)

Two Helpful IRS Fact Sheets on ACA
Per Thompson Reuters on Nov. 10 “Affordable Care Act Provisions Impacting Individuals and Employers: Two new IRS fact sheets provide details on key provisions of the ACA. The IRS notes the most important ACA tax provision for individuals and families is the premium tax credit and individuals without coverage and those who don’t maintain coverage throughout the year must have an exemption or make an individual shared responsibility payment. These provisions will affect 2014 income tax returns filed in 2015. For employers, the workforce size is significant because that’s what determines the applicable ACA provisions. Generally different rules apply to employers with fewer than 50 employees. IRS Fact Sheets FS-2014-09 and FS-2014-10 are available at http://www.irs.gov/uac/Newsroom/Fact-Sheets-2014.”

The employer mandate was delayed
Individuals have felt the brunt of Obamacare compliance over the individual mandate. President Obama issued an executive order to delay the employer mandate. But that delay is ending soon. See CNBC Nov. 11 Obamacare Cadillac plans? You’re gonna pay for that….

More changes
Prior to Obamacare, S-Corps could reimburse employees for health insurance on a tax-free basis by not including health insurance reimbursements in employee taxable wages. But starting in 2014, S-Corps must include the health insurance reimbursements in taxable wages for income, FICA and Medicare taxes. Don’t skip over making this change as the Obamacare law includes a fine of $100 per employee, per day. An employer group health insurance plan still delivers tax-free benefits to employees. (Postscript 2/18/15: The IRS issued relief for the above draconian penalty. Read more.)

Bottom line
Consult with your tax adviser to discuss how Obamacare taxes will affect your 2014 tax return and how it may be best for you to obtain coverage for 2015.  There’s still plenty of confusion and new surprises will arise, so stay tuned for updates on our blog.

Postscript Nov. 24, 2014: The IRS published new guidance on ACA’s individual mandate, hardship exemption, and premium tax credit. Notice 2014-76Rev Proc 2014-62 and final regs for Section 5000A on the individual mandate. Notice 2014-76 “Individual Shared Responsibility Payment Hardship Exemptions that May Be Claimed on a Federal Income Tax Return Without Obtaining a Hardship Exemption Certification from the Marketplace.” Rev Proc 2014-62 “This table is used to calculate an individual’s premium tax credit.” The Rev Proc “announces the indexed applicable percentage table in Code Sec. 36B(b)(3)(A), which is used to calculate an individual’s premium tax credit for tax years beginning after calendar year 2015.”

Darren Neuschwander, CPA and Star Johnson, CPA contributed to this article. 

 

2014 Year-End Tax Planning For Traders

October 21, 2014 | By: Robert A. Green, CPA

Forbes

Last Call For Tax Moves By Professional Traders

Join us for our Oct. 28 Webinar covering this blog, or watch the recording afterwards. 

Traders should consider general year-end planning strategies like deferring income and accelerating expenses, but they should also be aware of some other special tactics. In this article, I touch upon 20+ ideas for tax savings on your 2014 tax return.

1. Avoid NIT if you can.
As of Jan. 1, 2013, if you have adjusted gross income (AGI) over $250,000 (married) and $200,000 (single), then additional investment income will be subject to the 3.8% Net Investment Income Tax (NIT). (Read Net Investment Income Tax.)

2. Accelerate income to utilize lower tax brackets
There are some situations where it’s better to accelerate income and defer expenses, such as if you happen to be in a low tax bracket in 2014 due to trading losses and or other types of expenses and losses. Take advantage of ordinary tax rates up to 28%, a good regular tax rate and the highest alternative minimum tax (AMT) rate.

If you hold a security for 12 months before selling, it’s considered a long-term capital gain subject to rates that are lower than the ordinary rates for short-term capital gains. Look in your investment portfolio for positions with material unrealized capital gains. Consider selling some or all of the long-term winners before year-end. The long-term capital gain tax rate is graduated: 0%, 15% and 20%.  The 0% rate applies up to $73,800 of taxable income for married filing joint and $36,900 for single filers. The long-term rate applies to qualified dividends, too.

3. Accelerate more income with a Roth IRA conversion
Another good way to accelerate income to utilize lower tax brackets is by executing a Roth IRA conversion before year-end. You can break up an IRA into pieces in order to convert a certain amount. You can always recharacterize the conversion in 2015 if it doesn’t work well — for example, if you lose the money in the Roth account and prefer a do over or if your tax rates in 2015 are far lower than 2014. (Read my Oct. 7 blog Last chance to reverse 2013 Roth IRA conversion by Oct. 15, 2014.)

4. Get a handle on wash sale loss deferrals
Wash sale loss deferrals accelerate income if you don’t have a capital loss limitation. Many taxpayers hate wash sales because they cause tax liability on phantom income, with the IRS deferring losses into the next tax year.

Smart investors, business traders and investment managers spend November and December identifying and avoiding potential wash sale losses on “substantially identical positions” (i.e., between Apple stock and Apple options at different strike prices). Don’t wait until you receive broker-issued Form 1099-Bs in February to find out you have a huge tax problem with wash sale loss deferrals which might increase your 2014 tax bill significantly. (Read Cost-Basis Reporting and Form 8949.)

5. Use trade accounting software to better manage wash sales
Run trade accounting software before year-end to calculate and avoid wash sales, handle cost-basis reporting correctly and generate Form 8949 for tax filings. Keep running it through the end of January for wash sale loss calculations since they are triggered 30 days before and 30 days after taking a loss (if you re-enter that position). Once you spot a potential wash sale, sell all open positions before year-end and don’t buy them back for 31 days. (Read Accounting Solutions.)

6. Break the chain on wash sales with an entity
Consider trading in a separate entity in Q4 or on Jan. 1 to disconnect your individual trades under a different taxpayer ID number for the entity. A single-member LLC (SMLLC) disregarded entity doesn’t work here; you need a partnership or S-Corp return. (Read Entity Solutions.)

7. Avoid wash sales in IRAs
Don’t forget to run trade accounting software on your individual IRA accounts too. Avoid permanent wash sale losses between individual taxable accounts and IRAs. Don’t trade substantially identical positions between taxable and IRA accounts.

8. Take advantage of tax loss selling
Most financial media recommend “tax loss selling” as part of year-end tax planning. If you have capital gains year-to-date, sell a few losing positions to reduce capital gains taxes. Remember, don’t rush to buy back that losing position within 30 days (in January) as that can cause a wash sale loss deferral at year-end 2014, thereby defeating the purpose of tax loss selling.

9. Hold winning positions at year-end
Investors, business traders and hedge fund managers often hold open winning positions in securities with unrealized gains at year-end in order to defer taxes and perhaps achieve lower long-term capital gains rates in 2015 or subsequent years.

10. Utilize capital losses to maximum advantage
If you have significant capital losses and carryovers in 2014, consider selling open winning positions before year-end to utilize those capital losses. There’s no sense holding a winning position open for 12 months to achieve a long-term capital gain if that gain is offset with a capital loss carryover.

Per tax publisher Thompson Reuters, “Long-term capital losses are used to offset long-term capital gains before they are used to offset short-term capital gains. Similarly, short-term capital losses must be used to offset short-term capital gains before they are used to offset long-term capital gains. A taxpayer should try to avoid having long-term capital losses offset long-term capital gains since those losses will be more valuable if they are used to offset short-term capital gains or ordinary income.”

11. Section 475 traders are exempt from wash sale rules
Business traders should learn about Section 475 MTM business ordinary gain or loss treatment. While short-term capital gains on securities are taxed at ordinary rates, short-term capital losses are subject to the $3,000 capital loss limitation and problematic wash sale loss rules. The main tax benefit of Section 475 is that 475 trading losses are business ordinary losses without any limitation, and are included in net operating loss (NOL) calculations. Section 475 trades are exempt from the wash sale rules, too. New taxpayers (entities) are entitled to elect Section 475 within 75 days of inception, so this is a good solution for traders late in the year.  (Read Section 475 MTM Accounting.)

12. Turn 2014 unrealized capital losses into 2015 ordinary losses
If business traders qualifying for trader tax status don’t have Section 475 in 2014, they can elect it for 2015 by April 15, 2015. That 2015 election converts unrealized business trading gains and losses at the end of 2014 into ordinary gains or losses on Jan. 1, 2015 — that’s the required Section 481(a) adjustment. A negative Section 481(a) adjustment on Jan. 1 from unrealized losses on Dec. 31, 2014 is far better than a capital loss carried over from 2014 to 2015. In this case, wash sales are good because they are part of a Section 481(a) adjustment, rather than being a capital loss carryover. Traders generally have a hard time using up large capital loss carryovers. In this case, the business trader wants to skip tax loss selling and it’s beneficial to have an unrealized capital loss at year-end.

13. Learn the rules for segregation of investments
Some business traders and many hedge fund managers skip Section 475 MTM elections because they have a hard time following the rules for “contemporaneous” segregation of investments from business trading positions. The IRS is increasingly challenging traders over the segregation of investment rules. Hedge fund managers also don’t want investors paying taxes on open positions, as investors would request redemptions to pay the tax bill while managers have cash funds tied up in those open positions. (Read my Aug. 13 blog IRS warns Section 475 traders.)

14. Assess your qualification for trader tax status
Section 475 hinges on trader tax status (TTS), so active retail traders and hedge fund managers should assess their qualification before year-end. Sole proprietors and hedge funds can claim TTS after they assess the facts and circumstances, but Section 475 MTM is not allowed after the fact. It had to be elected with the IRS by April 15, 2014 for 2014 or within 75 days of a “new taxpayer” (i.e., a new entity) filed in the entity books and records (an internal election). (Read Trader Tax Status: How to Qualify.)

15. Forex can be ordinary or capital treatment
By default forex receives Section 988 ordinary gain or loss treatment. Forex traders may file an internal contemporaneous election (known as a forex “capital gains” election) to opt out of this treatment. Major forex forward contracts for which regulated futures contracts trade on U.S. futures exchanges are  labeled “foreign currency contracts” under Section 1256(g). Section 1256 has the tax benefit of lower 60/40 tax rates: 60% is subject to lower long-term capital gains rates and the other 40% is taxed at ordinary rates. Section 1256 is mark-to-market at year-end, whereas Section 988 is realized transactions only. We make a case for treating forex spot like forex forwards in Section 1256(g). (Read Forex tax treatment.)

16. Decide whether to accelerate or defer expenses.
Currently, 2015 tax rates match 2014 rates. This means if you are in a high tax bracket it’s a good idea to defer income and accelerate business expenses and itemized deductions. (Using credit cards on the last days of the year counts.) You may not qualify for TTS in 2015, so get business deductions while you still can. Investment expenses exclude home office, education, and startup costs. (Business expenses allow them.) If you don’t qualify for TTS at year-end but will in 2015, then defer business expenses to 2015.

17. Get employee-benefit plan deductions with entities
Trading gains are not considered earned income, so traders need an entity to pay the owner/trader compensation to unlock valuable employee-benefit-plan tax deductions, including retirement and health insurance premiums. (Traders generally save thousands of dollars with these strategies.) S-corps and C-corps should execute payroll and partnerships administration fees before year-end.  To avoid under-estimated tax penalties, increase tax withholding through year-end payroll. (Read Entity Solutions and watch our Oct. 22 Webinar recording Year-End Planning with Trader Entities.)

18. Establish retirement plans before year-end
Business traders should open an employer 401(k) plan before year-end in an S-Corp trading entity or C-Corp management company — otherwise, they will miss the boat on the best retirement plan choice for most traders. The 401(k) elective deferral ($17,500 for 2014 and $18,000 for 2015) is 100% deductible, plus it’s paired with a 25% employer profit-sharing plan allowing a total contribution of up to $52,000 for 2014 and $53,000 for 2015. There’s also a catch-up contribution ($5,500 for 2014 and $6,000 for 2015) for taxpayers age 50 and over. For sole proprietors, an Individual 401(k) plan has a 20% profit sharing plan, which is not as generous as the employer 401(k) plan.

Make sure to pay compensation before year-end to execute these employee-benefit plan deduction strategies. High income traders should consider a defined benefit (DB) plan where you can contribute much higher amounts per year (up to $210,000 for 2014).  DB plans require actuaries and attorneys and it takes time to set up. Consider different options for your retirement plan contributions, and whether you have sufficient cash flow to maximize this tax deduction. Can you afford a Roth contribution too? See 2014 retirement plan limits on the IRS site  (click here for DB plans). Don’t overlook required minimum distributions (RMD) rules for traditional retirement plans.  (Read Retirement Solutions and watch our Oct. 22 Webinar recording Year-End Planning with Trader Entities.)

19. Get a handle on accounting first
Focus on accounting before year-end to get a proper handle on tax planning. Accounting for securities trading is complex with cost-basis reporting, wash sales and reporting realized gains and losses only. We recommend trade accounting software to download your trades and handle this accounting.

20. GTT Tracker app for expense accounting
For expenses and asset purchases, we recommend our GTT Tracker accounting solution and app. Account for expenses and assets, including fixed assets (equipment), intangible assets (software), Section 195 startup costs and Section 248 organization costs. GTT Tracker prepares a full accounting and it properly documents your trading expenses and other business expenses. It’s a single-entry accounting system that is extremely effective and easy to use. The software allows you to download bank account and credit card transactions and follow IRS rules for compliance and documentation on a daily basis. Don’t be stuck trying to remember who you had dinner with and what the business purpose was at year-end. The IRS is tough on these issues in exams.

21. Expenses must be in order by year-end
Execute expense reimbursements before year-end — a requirement in S-Corps and suggested in partnerships. Learn how to handle the health insurance premium deduction, which is tricky with S-Corps. Employee-benefit plan deductions determine the amount of compensation needed to unlock those deductions. S-Corps should consider using salaries in December and engaging a payroll processing firm — we recommend paychex.com.

22. Get your Obamacare matters in order
The Patient Protection and Affordable Care Act (also known as Obamacare) enacted in 2012 has taken several years to implement and phase in. But now that the Obamacare 2014 individual health insurance mandate is in effect, many taxpayers will face confusion over tax penalties, exemptions, premium tax credits, claw backs of subsidies (advanced credits) and extra tax-preparation fees on 2014 tax filings. In this Webinar, we will clarify the details of the mandate to avoid confusion. 2014 is the second year for the Net Investment Income Tax (NIT). (Read my blog Obamacare ushers in several new tax forms for 2014.)

23. Consider a C-Corp
A C-Corp is taxed separately from individuals and the top C-Corp tax rate (35%) is lower than the top individual tax rate (up to 44% with NIT). But there’s also double taxation with C-Corps: once on the entity level and again when qualified dividends are paid on the individual level.  Double taxation is less of an issue in states with no individual income tax.

There are a number of ways to get income into the C-Corp. House intellectual property there, charging your trading entity royalties. Have the C-Corp get a profit allocation from the trading entity. Have the C-Corp charge the trading entity administration fees. C-Corps can have a medical reimbursement plan, which is a good way to pay for high deductible Affordable Care Act-compliant health insurance plans.

24. Catch up with estimated taxes at year-end
Don’t forget to get caught up with your 2014 estimated income taxes. Many traders underpay estimated taxes during the year, considering the underestimated tax penalty like a low-cost margin loan. The Q4 estimate is due Jan. 15, 2015, so you can see where you stand at year-end first. Consider paying the state(s) before year-end for another 2014 tax deduction, unless you trigger AMT and don’t get that benefit.

Will “Tax Extenders” Be Renewed Retroactively For 2014?

October 9, 2014 | By: Robert A. Green, CPA

The IRS commissioner recently told Congress that further delay on anticipated renewal of “tax extenders” will delay the 2014 tax-filing season and 2014 tax refunds. Many taxpayers are hoping Congress renews tax extenders retroactively to all of 2014 so it increases their 2014 tax refunds. I can see a case for non-renewal of tax extenders.

The IRS needs a long lead time
Each year, the IRS and tax publishers need to finalize tax forms and software on a timely basis. Last minute tax law changes often throw a monkey wrench into that process. When Congress passes new tax law, the IRS has to codify those laws with proposed regulations and final regulations. The last step is drafting and finalizing tax forms and related instructions. Factor in government bureaucracy and this entire process can take a lot of time. Congress passed the Affordable Care Act (ObamaCare) in March 2010, yet it took the IRS several years to finalize regulations and 2013 Net Investment Income Tax Form 8960. Form 8960 was released late for the 2013 tax filing season – delaying last year’s tax season. The IRS just released 2014 ObamaCare insurance-mandate tax forms, which is early in this case (see upcoming blog).

Renewal of tax extenders is not certain
Congress allowed the entire list of “tax extenders” to expire at the end of 2013. Unlike in prior years, Congress did not renew the tax extenders during its annual game of political brinksmanship. If Congress permanently passed tax extenders, it would blow a huge hole in the budget deficit forecast and that’s a political problem.

In “A major tax reform bill in 2014 is unlikely, and “tax extenders” may be history, too,” I predicted Republicans might block renewal of tax extenders for leverage in discussing an overhaul of the tax code – otherwise known as “tax reform.” Why pass a bunch of tax breaks separately, without taking the opportunity to also simplify and fix the tax code at the same time?

My latest thoughts about tax extenders and tax reform
Why pass tax extenders just before the major election in November 2014? Congressmen campaign on tax policy raising money from the tax-benefit lobby. Pundits currently predict that Republicans may win narrow control of the Senate, but not filibuster-proof. Republicans could press for their vision of tax reform with the mantle in both houses of Congress. With ongoing public controversy over corporate tax inversions and U.S. companies moving abroad, a Republican Congress can probably exert pressure on the White House to pass corporate tax reform. Most small businesses uses pass-through entities like LLCs and S-Corps, which means they pay their business taxes on individual tax returns. For this reason, Congress should include individual tax reform in the tax reform bill, too. You can’t leave a large gap between individual and corporate tax rates.

The 2015 Congress sits in late January 2015, which means the 2014 lame-duck Congress will deal with year-end calls for renewing tax extenders. It’s highly unlikely the latter will deal with tax reform.

Is the IRS Commissioner weighing in to politics by pressuring Congress on tax extenders before the November election? Tax extenders lapsed at the end of 2013. Shouldn’t the IRS create tax forms based on current tax law? It’s certainly not easy with a last-minute Congress.

I vote for tax reform over just renewing tax extenders. For those that cry wolf, I question if corporations will reduce their research and development, or investments in new technology and equipment simply because the U.S. Treasury won’t subsidize them. American big and small businesses need to innovate and stay technologically advanced or they will lose their worldwide competitive edge.

As we approach the year-end holidays, many lobbyists, corporations and individuals will write letters to their Congressmen crying foul over tax extenders, Congress may cave and renew tax extenders. It’s tough to do tax planning with this routine.

Tax Relief For Canadians Living In The U.S.

| By: Robert A. Green, CPA

In the past, many Canadians living in the U.S. were surprised and dismayed to learn they owed U.S. taxes, penalties and interest on income accumulating inside their Canadian retirement plans. These U.S. residents figured their Canadian retirement plans were automatically afforded the same tax-deferral treatment as U.S. retirement plans, with income only being taxable when distributed from the plan. They were unaware they had to file an IRS election for deferral treatment.

That wasn’t the only surprise — many Canadians didn’t realize they had to report Canadian retirement plans on U.S. Treasury FBAR filings (foreign bank account reports).

We’re happy to see the IRS acknowledged the tax-deferral problem and it now provides relief. In Revenue Procedure 2014-55, the IRS repeals the need for filing a tax election, which means Canadian retirement plans automatically qualify for tax deferral. The new rules are retroactive, so it abates back taxes, interest and penalties and that spells “relief.”

This relief applies to U.S. taxpayers with Canadian registered retirement savings plans (RRSPs) and registered retirement income funds (RRIFs). The IRS altered regulations governing annual reporting requirements, mostly doing away with the election requirement and there is no longer a need to file Form 8891 (U.S. Information Return for Beneficiaries of Certain Canadian Registered Retirement Plans).

Foreign retirement accounts must still be reported on FinCEN Form 114, Report of Foreign Bank and Financial Account. (Read more on International Tax Matters in our Trader Tax Center.)