CARES Act Allows 5-Year NOL Carrybacks For Immediate Tax Refunds

March 28, 2020 | By: Robert A. Green, CPA | Read it on

Live Updates:

March 28: On March 27, 2020, Congress and the president enacted into law the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”). This virus bill includes significant economic aid and tax relief provisions. Some tax relief applies retroactively to 2018, 2019, and 2020. Today, I focus on NOL carrybacks.

If you have a “net operating loss” (NOL) from business activities in 2018, 2019, and 2020, you should consider filing NOL carryback claims going five years back. 

Active traders, eligible for trader tax status (TTS), are businesses with NOLs, too. A TTS trader might have significant trading expenses and or Section 475 ordinary losses comprising an NOL. 

CARES temporarily suspends tax loss limitations on businesses under TCJA for 2018, 2019, and 2020. TCJA had repealed two-year NOL carrybacks and only allowed NOL carryforwards limited to 80% of the subsequent year’s taxable income. TCJA introduced the “excess business loss” (EBL) limitation, where aggregate business losses over an EBL threshold ($500,000 married, and $250,000 other taxpayers for 2018), were considered an NOL carryforward. 

CARES lifts the above TCJA limitations allowing taxpayers to recalculate 2018 and 2019 NOLs and to file NOL carryback refund claims going back five years for immediate tax relief. Taxpayers will be able to carryback 2020 NOLs five years, too, but not until they file 2020 tax returns in 2021. 

TTS traders with Section 475 ordinary losses, and TTS traders without 475 but who have significant NOLs from expenses (i.e., borrow fees on short-selling), should consider NOL carrybacks, too. 

Here’s an example
Joe Smith, a TTS trader with Section 475, filed a 2018 income tax return showing an NOL of $400,000. Joe’s NOL came from $50,000 of trading expenses, $350,000 of Section 475 trading losses, and he had no other income or loss.

Under TCJA, Joe did an NOL carryforward, his only option, and his draft 2019 tax return has a low income, which will utilize a small portion of his NOL. Joe has more trading losses and expenses YTD for 2020, so he is holding a deferred tax asset. Joe is thrilled that CARES opens the door to NOL carrybacks because he had substantial taxable income from other activities in years previous to 2018. 

We await IRS and state guidance on CARES to indicate precisely how Joe and his tax preparer should proceed with NOL recalculation and carryback returns. We have questions:

  1. Must taxpayers with EBL limitations amend 2018 tax returns to do away with EBL, and to recalculate NOLs? Is CARES retroactive application to 2018 and 2019 an optional or mandatory requirement? Some taxpayers might prefer to leave things the way they are under TCJA.
  2. CARES allows taxpayers to carryback NOLs from 2018, 2019, and 2020 five years. Usually, tax years close after three years, so how will it work for 2018 NOL five-year carrybacks? For example, 2016 income tax returns filed by April 15, 2017, might close three years after by April 15, 2020. Is that postponed to July 15, 2020, with the IRS relief? Can a taxpayer go back five years before 2018? 
  3. The usual tax deadline for filing a 2018 Form 1045 (Application for Tentative Refund) for NOL carrybacks, is December 31, 2019. We prefer using 1045 since the IRS must address the form within 90 days. Alternatively, taxpayers use Form 1040X (Amended U.S. Individual Income Tax Return) for each NOL carryback year, which often takes the IRS six months or more to address and pay the refunds? There are other procedural questions beyond the scope of this blog post. 
  4. Which states will conform with CARES on these tax changes, especially NOL carryback refund claims? During the Great Recession of 2008 and 2009, stimulus tax legislation allowed more-generous NOL carrybacks. However, some states decoupled from federal law on those changes. For example, California did not allow NOL carrybacks at all, and it restricted NOL carryforwards in several ways. 

Stay tuned to our blog post for updates on NOLs, and I plan to cover other CARES tax changes that affect TTS traders, too. 

March 27: Congress and the president enacted into law the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). This “virus bill” includes significant economic aide and tax provisions to help all taxpayers. The House did not make any changes to the Senate version below.

If you were eligible for trader tax status (TTS) in 2018, 2019, and 2020, and had significant trading expenses and or Section 475 ordinary loss treatment on trading losses, then consider filing NOL carryback refund claims under the CARES Act.

March 25: Senate Passes Updated Economic Relief Plan (CARES Act) for Individuals and Businesses (Tax Foundation). The final version of the law included the tax loss provisions covered in the March 20 update below. Here are the code sections from Thomson Reuters CheckPoint:

  • “NOLs arising in a tax year beginning after December 31, 2018 and before January 1, 2021 can be carried back to each of the five tax years preceding the tax year of such loss. (Code Sec. 172(b)(1) as amended by Act Sec. 2303(b)(1))
  • temporarily removes the taxable income limitation to allow an NOL to fully offset income. (Code Sec. 172(a), as amended by Act Sec. 2303(a)(1))
  • temporarily modifies the loss limitation for noncorporate taxpayers so they can deduct excess business losses arising in 2018, 2019, and 2020. (Code Sec. 461(l)(1), as amended by Act Sec. 2304(a))
  • temporarily and retroactively increases the limitation on the deductibility of interest expense under Code Sec. 163(j)(1) from 30% to 50% for tax years beginning in 2019 and 2020. (Code Sec. 163(j)(10)(A)(i) as amended by Act Sec. 2306(a)).” (See special rules for partnerships.)

March 20: Congress should proceed with new legislation like the “Coronavirus Aid, Relief, and Economic Security Act,” or “CARES Act,” to provide additional tax relief, beyond the Treasury Department moving the April 15 tax deadline to July 15, 2020.

Leader McConnell’s CARES Act bill temporarily suspends the “Tax Cuts and Jobs Act” (TCJA) business loss limitations, including reauthorizing NOL 5-year carrybacks, repealing the excess business loss (EBL) limitation, and loosening the business interest expense limitation. That’s fantastic news, as businesses need tax relief for losses ASAP. Here are the related CARES Act provisions:

  • 2203: Section 172(b)(1) – “Net Operating loss carrybacks and carryovers” – Special Rule for losses arising in 2018, 2019 and 2020, such loss shall be a net operating loss carryback to each of the 5 taxable years preceding the taxable year of such loss.
  • 2203: Temporary repeal of 80% income limitation to deduct a 2018 and forward NOL for year beginning before 2021.
  • 2204: Repeal of 461(l) for 2018, 2019 and 2020 – excess business losses.
  • 2206: 163(j) special rules for 2019 and 2020, increasing ATI percentage from 30% to 50% for limitation on business interest.

CPA industry groups are also asking Congress to raise the $3,000 capital loss limitation, which they never indexed for inflation.

Treasury Secretary Steven Mnuchin announced President Trump’s directive to move the April 15 tax deadline to July 15, 2020, thereby postponing tax filings and tax payments for all taxpayers. Mnuchin said the extension would give “all taxpayers and business this additional time” to file returns and make tax payments “without interest or penalties.” I expect Treasury and the IRS will issue specific guidance, including FAQs, soon. Hopefully, all states will follow suit with this federal change, so taxpayers don’t face conflicting rules.

Traders and 475 elections: Although it’s not guaranteed, I think the IRS might accept a 2020 Section 475 election submitted by July 15, 2020, since that is the new tax filing date. It would afford traders 90 days of additional hindsight. IRS FAQs might not address elections, although the CARES Act bill includes moving of election deadlines, too. If you have a massive Q1 2020 trading loss as a trader eligible for trader tax status (TTS), and you are counting on an NOL carryforward, or carryback if allowed, then it might be wise to file an extension by April 15, 2020, and attach a 2020 Section 475 election statement. I think you should be able to revise the election by July 15, 2020, if warranted. (See Massive Market Losses? Elect 475 For Enormous Tax Savings.)

March 19: Senator John Thune introduced a two-page bill “Tax Filing Relief for America Act” “To extend the due date for the return and payment of Federal income taxes to July 15, 2020, for taxable year 2019.” Treasury and the IRS recently issued guidance to delay certain tax payments for 90-days until July 15, 2020. Still, Treasury did not postpone the April 15 tax filing deadline, putting an undue burden on taxpayers and accountants. Thune’s legislation syncs tax filings with tax payments in a simple manner, whereas Treasury’s guidance is causing tremendous confusion. Leader McConnell just introduced the “Coronavirus Aid, Relief, and Economic Security Act,” or “CARES Act,” which incorporates Thune’s bill. Thanks to the AICPA for pushing Congress and Treasury hard to get this critical April 15 tax relief. Why rush a 4/15 tax filing, if Treasury already postponed tax payments; that could expose clients and accountants to contracting coronavirus. See the AICPA Coronavirus Resource Center.

For prior updates, see Updated: April 15 Tax Deadline Moved To July 15.


Massive Market Losses? Elect 475 For Enormous Tax Savings

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

Live updates

March 25: Our Darren Neuschwander CPA emailed and spoke with the IRS Chief Counsel’s office for Section 475(f) MTM elections. Mr. Neuschwander asked these IRS officials whether the tax deadline for submitting a 2020 Section 475 election is April 15, 2020, or July 15, 2020, considering that the IRS postponed the April 15 deadline to July 15. The IRS did not cover this question in its first release of FAQs. In our email to the IRS, we gave our rationale for why it should be July 15 (see March 24 update below).

The IRS official told us to watch for an IRS FAQ, which they might add to answer our question, although she gave us no assurances or a timeline.

In the meantime, the IRS official highly recommends that if someone wants to elect 475 MTM for 2020, they should file the election statement by attachment to a 2019 tax extension (Form 4868) mailed to the IRS by the regular tax deadline of April 15, 2020. That’s what Rev Proc 99-17 requires. The IRS tracks 475 elections with extensions or tax return filings, but not if the taxpayer sends a separate letter with the election. It’s okay if the taxpayer files another extension Form 4868 on July 15, 2020, to pay 2019 taxes owed. The IRS official reminded us that the IRS does not grant tax relief for late-filed 475 elections.

As we said on these blog updates for over a week, until and unless the IRS is explicit in allowing 475 elections by July 15, we advise clients to make 2020 Section 475 MTM elections on securities and or commodities by April 15, 2020. Prepare the 2019 tax extension with the 2020 election statement attachment, but wait until it’s closer to April 15 deadline. Meanwhile, monitor the IRS FAQs and our blog post to see if the IRS accepts an election by July 15, 2020, postponed deadline.

What’s the fuss?
A Section 475 election could be a savior this year with extreme volatility and some TTS traders incurring massive trading losses. Instead of having a capital loss limitation of $3,000, you’ll have unlimited ordinary losses, and perhaps a net operating loss (NOL) carryback refund.

Pending stimulus legislation suspends the TCJA business loss limitations, including reauthorizing NOL 5-year carrybacks for 2018, 2019, and 2020, and repealing the excess business loss (EBL) restriction. TTS traders with 475 elections would get immediate tax relief with NOLs 5-year carrybacks. That can replenish your trading account and keep you in business!

March 24: The IRS published FAQs to support Notice 2020-18 for the April 15 tax-deadline postponement to July 15: Filing and Payment Deadlines Questions and Answers. CPA industry groups will likely ask for another round of FAQs to address unanswered questions. It’s important to note that FAQs are not yet “substantial authority,” as tax notices are, and the IRS often changes FAQs at a future date like they recently did with cryptocurrency.

  • Elections: The FAQs don’t mention the word “elections,” including the Section 475 election for TTS traders. The Section 475 MTM election wording comes directly from Rev Proc 99-17, which states:

    “The (election) statement must be filed not later than the due date (without regard to extensions) of the original federal income tax return for the taxable year immediately preceding the election year and must be attached either to that  return or, if applicable, to a request for an extension of time to file that return.”

    In the Notice 2020-18, the IRS moved the due date for 2019 individual tax returns to July 15. The above Q12 allows an automatic extension request on July 15 for more time to file. It seems logical to conclude that a 2020 Section 475 election is due July 15. If the IRS does not explicitly address this question, then a TTS trader with a massive 2020 YTD trading loss might want to file a protective extension request with 475 election statement attachment by April 15, 2020, to play it safe.

March 20: It’s not yet certain if the IRS will accept a 2020 Section 475 election submitted by July 15, 2020, in conformity with the postponed tax filing deadline. It would afford traders 90 days of additional hindsight. The IRS promised FAQs soon, which might address “elections.” The original CARES Act bill included the moving of election deadlines, too. (Update March 23: However, the latest version of the CARES Act bill removed that entire section, perhaps because Treasury already moved the tax deadline to July 15). If you have a significant Q1 2020 trading loss as a trader eligible for trader tax status (TTS), and you are counting on 475 ordinary loss treatment, then it’s currently safer to file an extension by April 15, 2020, and attach a 2020 Section 475 election statement. Stay tuned to our blog posts about the election issue. (See April 15 Tax Deadline Moved To July 15.)

Original blog post, dated February 29, 2020:

With heightened market volatility in Q1 2020, many traders incurred massive losses. Those who qualify for trader tax status (TTS) should consider a 2020 Section 475 election to turn capital losses into ordinary losses. Don’t get stuck with a $3,000 capital loss limitation for 2020 and a considerable capital loss carryover to 2021; unlock immediate tax savings with ordinary-loss deductions against wages and other income this year.

Election procedures: Existing TTS partnerships and S-Corps should attach a 475 election statement to their 2019 entity tax return or extension due March 16, 2020. TTS sole proprietors (individuals) should attach a 475 election statement to their 2019 income tax return or extension due April 15, 2020. The second step is to file a 2020 Form 3115 (Application for Change in Accounting Method) with your 2020 tax return. There are other benefits: 475 trades are exempt from dreaded wash sale loss adjustments, and profitable 475/TTS traders are eligible for the 20% QBI deduction if they are under the QBI taxable income thresholds.

Example 1: A TTS securities trader incurred a capital loss of $103,000 in Q1 2020. He elects Section 475 on securities only for 2020 by April 15, 2020, converting the Q1 capital loss into an ordinary loss on Form 4797 Part II. He also plans to deduct $12,000 of trading business expenses on a Schedule C. He intends to offset the entire trading business loss of $115,000 against a wage income of $175,000 for a gross income of $60,000. Without a 475 election, this trader would have a $3,000 capital loss limitation on Schedule D, a $12,000 ordinary loss on Schedule C, and a gross income of $160,000. He would also have a capital loss carryover to 2021 of $100,000. By deducting the entire $100,000 in 2020 with a 475 election, the trader generates a considerable tax refund.

More about 475
Traders eligible for TTS have the option to make a timely election for the Section 475 accounting method on securities and/or commodities. Section 475 is mark-to-market (MTM) accounting with ordinary gain or loss treatment. MTM imputes sales of open positions at the year-end at market prices. Without MTM, securities traders use the realization (cash) method with capital gains and loss treatment, including wash sale loss adjustments and the annual $3,000 capital loss limitation.

Caution: Sole proprietor (individual) TTS traders who missed the Section 475 MTM election date (April 15, 2019, for 2019) can’t use ordinary-loss treatment for 2019 and are stuck with capital gains and losses and perhaps capital-loss carryovers to 2020. Carefully consider a 475 election for 2020, as you need capital gains to use up capital loss carryovers, and 475 is ordinary income.

A new entity set up after April 15, 2020, could deliver Section 475 MTM for the rest of 2020 on trading losses generated in the entity account if it filed an internal Section 475 MTM election within 75 days of inception.

Ordinary losses offset all types of income (wages, portfolio income, and capital gains) on a joint or single filing, whereas capital losses only offset capital gains. Plus, business expenses and ordinary trading losses comprise a net operating loss (NOL) carry forward.

By making a 475 election on securities only, TTS traders retain lower 60/40 capital gains rates on Section 1256 contracts (futures), and they can segregate investment positions for long-term capital gains.

The new tax law TCJA introduced an “excess business loss” (EBL) limitation starting in 2018. For 2019 the inflation-adjusted EBL limitation is $510,000 married and $255,000 other taxpayers. The EBL applies to Section 475 ordinary losses and trading expenses. Add an EBL to an NOL carryforward. For example, a single taxpayer with a $300,000 ordinary loss from 475 and trading costs, and no other wage or business income, might have an EBL of $45,000.

TCJA offers a 20% qualified business income (QBI) tax deduction for pass-through businesses, including sole proprietors. TTS trading is a specified service activity. QBI includes 475 ordinary income; whereas, it excludes capital gains/losses, portfolio income, and forex. TTS expenses are negative QBI. A profitable TTS/475 trader is eligible for the QBI deduction providing their taxable income is not over the QBI thresholds.

Don’t miss the 475 election deadline
Applying for 9100 relief within six months of the 475-election due date by private letter ruling (PLR) is an expensive process, and it’s likely to fail. Only one trader won this type of relief, Mr. Vines displayed no hindsight and good faith, and he had a perfect set of factors. In a recent PLR 202009013, dated November 15, 2019, the IRS ruled, “Taxpayers are not entitled to § 301.9100 relief to make a late § 475(f)(1) election because Taxpayers did not act reasonably and in good faith and granting relief would prejudice the interests of the Government.”

For more information and a sample 475 election statement, see Green’s 2020 Trader Tax Guide, Chapter 2, on Section 475 MTM.

Darren Neuschwander CPA contributed to this blog post.


April 15 Tax Deadline Moved To July 15

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

Live Updates: See our live updates on moving the tax deadline, whether it applies to 475 elections, and which states conform.

March 25: 475 elections: Our Darren Neuschwander CPA emailed and spoke with the IRS Chief Counsel’s office for making Section 475(f) MTM elections about whether to file a Section 475 MTM election by April 15 or July 15. (See the full update on our separate blog post Massive Market Losses? Elect 475 For Enormous Tax Savings.)

State taxes: AICPA State Tax Filing Relief Chart for Coronavirus “States are providing tax filing relief for individuals and businesses. Check out the latest developments on state tax filings related to coronavirus.” Including state that conformed to the IRS postponement of the April 15 deadline to July 15. For example, New Jersey had not as of this morning. 

AICPA Calls on Treasury, IRS to Provide Extensive Relief to Taxpayers. IRS Notice 2020-18 and related FAQs are helpful, but I agree with the AICPA that taxpayers need broader relief from Treasury. See the IRS Coronavirus Tax Relief page.

March 24: The IRS published FAQs to support Notice 2020-18 for the April 15 tax-deadline postponement to July 15: Filing and Payment Deadlines Questions and Answers. CPA industry groups will likely ask for another round of FAQs to address unanswered questions. It’s important to note that FAQs are not yet “substantial authority,” as tax notices are, and the IRS often changes FAQs at a future date like they recently did with cryptocurrency.

  • The IRS moved the IRA and HSA contribution deadlines from April 15 to July 15 (Q17 and Q21).
  • July 15 extensions: FAQ A12. “If you are an individual, you can request an automatic extension to file your Federal income tax return if you can’t file by the July 15 deadline. The easiest and fastest way to request a filing extension is to electronically file Form 4868 through your tax professional, tax software, or using the Free File link on IRS.gov. Businesses, including trusts, must file Form 7004. You must request the automatic extension by July 15, 2020. If you properly estimate your 2019 tax liability using the information available to you and file an extension form by July 15, 2020, your tax return will be due on October 15, 2020. To avoid interest and penalties when filing your tax return after July 15, 2020, pay the tax you estimate as due with your extension request.”
  • Elections: The FAQs don’t mention the word “elections,” including the Section 475 election for TTS traders. The Section 475 MTM election wording comes directly from Rev Proc 99-17, which states:

    “The (election) statement must be filed not later than the due date (without regard to extensions) of the original federal income tax return for the taxable year immediately preceding the election year and must be attached either to that  return or, if applicable, to a request for an extension of time to file that return.”

    In the Notice 2020-18, the IRS moved the due date for 2019 individual tax returns to July 15. The above Q12 allows an automatic extension request on July 15 for more time to file. It seems logical to conclude that a 2020 Section 475 election is due July 15. If the IRS does not explicitly address this question, then a TTS trader with a massive 2020 YTD trading loss might want to file a protective extension request with 475 election statement attachment by April 15, 2020, to play it safe.

March 23: After Treasury moved the tax deadline to July 15, a newer version of the CARES Act bill removed the section about shifting the tax deadline “and elections” to July 15. Perhaps, because Treasury already made the deadline postponement. The IRS has not yet addressed moving elections and IRA and HSA deadlines to July 15. The open question is: Can TTS traders submit a 475 election by July 15, 2020? The regular due date for a 475 election is April 15. Treasury and the IRS promised FAQs about the deadline postponement soon, and hopefully, it will answer open questions about elections, IRAs, and HSAs.

March 20: Treasury Secretary Steven Mnuchin announced President Trump’s directive to move the April 15 tax deadline to July 15, 2020, thereby postponing tax filings and tax payments for all taxpayers. The new rules in Notice 2020-18 remove the $1M cap on individuals included in the superseded Notice 2020-17, so all tax payments are penalty and interest-free until July 15, 2020. Mnuchin said the extension would give “all taxpayers and business this additional time” to file returns and make tax payments “without interest or penalties.” The Treasury Department promised FAQs soon. Hopefully, all states will follow suit with this federal change, so taxpayers don’t face conflicting rules.

Congress should proceed with new legislation like the “Coronavirus Aid, Relief, and Economic Security Act,” or “CARES Act,” to provide additional tax relief, beyond the Treasury Department moving the April 15 tax deadline to July 15, 2020. Leader McConnell’s CARES Act bill temporarily suspends the “Tax Cuts and Jobs Act” (TCJA) business loss limitations, including reauthorizing NOL 5-year carrybacks, repealing the excess business loss (EBL) limitation, and loosening the business interest expense limitation. That’s fantastic news, as businesses need tax relief for losses ASAP. Here are the related CARES Act provisions:

  • 2203: Section 172(b)(1) – “Net Operating loss carrybacks and carryovers” – Special Rule for losses arising in 2018, 2019 and 2020, such loss shall be a net operating loss carryback to each of the 5 taxable years preceding the taxable year of such loss.
  • 2203: Temporary repeal of 80% income limitation to deduct a 2018 and forward NOL for year beginning before 2021.
  • 2204: Repeal of 461(l) for 2018, 2019 and 2020 – excess business losses
  • 2206: 163(j) special rules for 2019 and 2020, increasing ATI percentage from 30% to 50% for limitation on business interest

CPA industry groups are also asking Congress to raise the $3,000 capital loss limitation, which they never indexed for inflation. Stay tuned.

Traders and 475 elections: It’s not yet certain if the IRS will accept a 2020 Section 475 election submitted by July 15, 2020, in conformity with the postponed tax filing deadline. It would afford traders 90 days of additional hindsight. The IRS promised FAQs soon, which might address “elections.” The original CARES Act bill included the moving of election deadlines, too. (Update March 23: However, the latest version of the CARES Act bill removed that entire section, perhaps because Treasury already moved the tax deadline to July 15). If you have a significant Q1 2020 trading loss as a trader eligible for trader tax status (TTS), and you are counting on 475 ordinary loss treatment, then it’s currently safer to file an extension by April 15, 2020, and attach a 2020 Section 475 election statement. Stay tuned to our blog posts about the election issue. (See Massive Market Losses? Elect 475 For Enormous Tax Savings.)

March 19: Senator John Thune introduced a two-page bill “Tax Filing Relief for America Act” “To extend the due date for the return and payment of Federal income taxes to July 15, 2020, for taxable year 2019.” Treasury and the IRS recently issued guidance to delay certain tax payments for 90-days until July 15, 2020. Still, Treasury did not postpone the April 15 tax filing deadline, putting an undue burden on taxpayers and accountants. Thune’s legislation syncs tax filings with tax payments in a simple manner, whereas Treasury’s guidance is causing tremendous confusion. Leader McConnell just introduced the “Coronavirus Aid, Relief, and Economic Security Act,” or “CARES Act,” which incorporates Thune’s bill. Thanks to the AICPA for pushing Congress and Treasury hard to get this critical April 15 tax relief. Why rush a 4/15 tax filing, if Treasury already postponed tax payments; that could expose clients and accountants to contracting coronavirus. See the AICPA Coronavirus Resource Center. Stay tuned.

March 18: Treasury issued guidance in Notice 2020-17. It’s now official: As usual, individuals must file extensions on Form 4868 by April 15. Just by submitting this form with little tax information, it avoids excessive late-filing penalties, which are 5% per month up to 25% maximum on balance-due payments. The coronavirus relief only allows individuals to defer income tax payments up to $1M until July 15, 2020, without application of interest and “penalties,” and I think they mean late-payment penalties of 0.5% per month up to 5% maximum. Taxpayers can file a one-page extension Form 4868 without making tax payments until July 15, 2020. That should make quick work of the extension, which is essential as many taxpayers and accountants are overwhelmed with the impact of coronavirus. This Treasury guidance includes deferral for Q1 2020 estimated tax payments due by April 15, 2020, but not Q2 on June 15, 2020. (See IRS Notice 2020-17 with highlights.)

March 17: Treasury Secretary Mnuchin said: If you owe a tax payment to the IRS, you can defer up to $1M as an individual and $10M as a C-corp. Tax payments will be interest and penalty-free if you file within 90 days of the April 15 deadline.” “All you have to do is file your taxes,” he said. “You’ll automatically not get charged interest and penalties.” We need to see the fine print; there are many open questions. Mnuchin’s statement indicates taxpayers should still file an automatic extension on Form 4868 by April 15, 2020, to extend the tax return filing deadline six-months until October 15, 2020. If a taxpayer cannot file an extension by April 15 due to the impact of coronavirus, then the IRS would be hard-pressed to deny reasonable cause for abatement of late-filing penalties.

– Per Bloomberg Tax, “Updates to make clear that taxpayers still must file by April 15 or seek an extension.” And, “The administration is also considering delaying the estimated quarterly tax payments that self-employed workers and businesses pay the IRS throughout the year, according to two people familiar with the matter. The first payment is typically due April 15.”

– Traders should file Section 475 elections by the April 15, 2020 deadline, since Treasury didn’t change the April 15 deadline; they are providing a 90-day extension for tax payments. I doubt Treasury wants to give traders 90 more days of hindsight on making 475 elections.

March 15: AICPA News: “Based upon our conversations, we anticipate that Treasury and the IRS will announce this week an extension of the April 15 deadline by as much as 90 days, and a waiver of penalties and interest for most taxpayers. Additionally, Treasury and the IRS are aware of the major deadline for businesses tomorrow, March 16, and the challenges facing taxpayers and tax preparers in meeting that deadline.  They have indicated that they would be generous in determining reasonable cause abatement of any penalties for taxpayers and tax preparers unable to file in a timely manner.”

March 13 at 3 pm ET: Per Tax Talks, “President Trump declared a national emergency under the Robert T. Stafford Disaster Relief and Emergency Assistance Act in response to the coronavirus. This declaration allows the Treasury Department and the IRS to extend the deadline for certain taxpayers and small businesses to pay taxes until December 31, 2020 as Treasury Secretary Steven Mnuchin suggested earlier this week.

Per Bloomberg Law News, (With this declaration) “the IRS can choose from a range of powers: abating penalties for failing to file or pay taxes, or postponing federal tax filing and payment deadlines without interest or penalties accruing, according to the agency’s Internal Revenue Manual posted on its website.”

March 13 at 1 pm ET: The president will probably use federal emergency powers today to direct the Treasury Department to provide tax filing and late payment relief. I hope the Treasury Department considers the AICPA proposals. (See the AICPA coronavirus resource center and the AICPA state filing conformity chart that they will update.)

The original blog post, dated March 12, 2020:

The Administration and Congressional leaders are negotiating fiscal-stimulus measures to provide relief for the coronavirus pandemic, which might include loosening rules for the April 15th tax deadline.

In his Oval Office speech on March 11, the president proposed tax-payment relief for “certain individuals and businesses.” That might be too narrow, and hopefully, this relief will apply to all taxpayers since the virus is spreading fast around the county and causing wide-spread economic harm. It would be challenging to identify “federally declared disaster areas” eligible for tax relief. Blanket across the board tax relief is warranted. Treasury Secretary Mnuchin said the delay would cover “virtually all Americans other than the super-rich.”

Under current law, individual taxpayers must file 2019 income tax returns or an automatic extension form 4868 by April 15, 2020. An extension filing delays the tax-filing deadline for six-months until October 15, 2020. However, the IRS and states want taxpayers to make 2019 tax payments on time by April 15, 2020. The IRS uses a complicated regime of penalties and interest charges to incentivize taxpayers to make tax payments by April 15.

If a taxpayer misses the April 15 deadline, the IRS charges them a “late-filing penalty” of 5% per month, up to a maximum of five months for a total penalty of 25%. It would be unconscionable for the IRS to charge a coronavirus victim such a hefty penalty because they couldn’t file a one-page extension on time. I expect that IRS relief should make this automatic extension genuinely “automatic” by doing away with a requirement to submit a form 4868.

The IRS “late-payment penalty” addresses when a taxpayer should make tax payments that are due. IRS coronavirus relief should loosen the late-penalty rules, too. Under current law, the IRS would charge a late-payment penalty if the taxpayer did not pay at least 90% of their tax liability by April 15. The late-payment penalty is 0.5% per month, up to five months for a maximum of 2.5%. The IRS allows the taxpayer to request abatement of late-payment and late-filing penalties based on a “reasonable cause.” Contracting coronavirus sounds like a reasonable cause. The IRS calculates penalties and interest based on the tax payment paid after April 15. The current interest rate on late payments is 4.5%.

Hopefully, states follow suit with the IRS and enact coordinated tax relief over the April 15 deadline. States might use a different payment percentage to avoid late-payment penalties.

Accounting industry group weighs in
The AICPA issued a press release AICPA Calls for Indiv. & Business Tax Relief Amid Coronavirus Pandemic, dated March 11, 2020. My partner Darren Neuschwander CPA serves on the AICPA Individual & Self-Employed Tax Technical Resource Panel, and Darren helped draft this AICPA letter. (Darren will be serving as the vice-chair of the panel effective May 21, 2020, for the 2020-2021 year.)

The AICPA letter recommended an automatic extension for all taxpayers, without having to submit form 4868. The AICPA also suggested reducing the 90% payment rule to 70%, figuring the IRS might then provide the relief to all taxpayers. The AICPA letter further recommends: “Waive interest through October 15, 2020; and waive underpayment penalties for 2020 estimated tax payments if paid by September 15, 2020.” See the letter for their other recommendations.

On CNBC this morning, Jim Cramer called for tax payment relief across the board for all taxpayers and businesses. It seems the public and media’s first impression of this story is that “no tax payments” will be due April 15 with an automatic extension. And, there will be 100%-relief for interest and all types of penalties. The fine-print of the penalty regime has always been confusing to many. Let’s wait to see the final tax law changes if any.

Special issues for traders
A 2020 Section 475 election is due by April 15, 2020, for individual traders eligible for trader tax status (TTS). (It’s March 16 for existing partnerships and S-Corps.) The 475-election procedure requires a taxpayer to attach a 2020 Section 475 election statement to their 2019 tax return or extension filing made by the April 15, 2020 deadline. The IRS might allow an automatic extension without a 4868 filing required, or they could extend the filing date altogether. However, I don’t expect the IRS to address 475 elections specifically. Therefore, it’s safer to mail the IRS a Form 4868 automatic extension and staple the 475-election statement to it by April 15, 2020, according to current law. Alternatively, file a complete 2019 tax return with the 475-election included by April 15. This year traders are counting on a 475 election to convert year-to-date capital losses into ordinary losses due to massive volatility in Q1 2020. (See Massive Market Losses? Elect 475 For Enormous Tax Savings.)

It’s worth noting that the late-payment penalty is small and sort of like a margin loan; a maximum amount of 2.5% isn’t that bad for six months’ use of money.

If you do choose to postpone tax payments, be careful not to risk your tax funds owed the IRS in the financial markets as that might compound your cash flow problems.

This tax relief is like interest forbearance where banks allow a delay in mortgage payments, which many financial institutions offered to do in this crisis. It’s time for the U.S. Treasury to provide tax-payment forbearance, too.

See our blog post on extensions from last year Tax Extensions: 12 Tips To Save You Money.

Please share this blog post with Administration and Congressional leaders.

Darren Neuschwander CPA contributed to this blog post.

 


Updated: March 16 Is Tax Deadline For S-Corp And Partnership Extensions And Elections

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

Live Updates

March 24: The IRS published FAQs to support Notice 2020-18 for the April 15 tax-deadline postponement to July 15: Filing and Payment Deadlines Questions and Answers. 2019 partnership and S-Corp tax returns or extensions due March 16, 2020, are not eligible for this IRS relief. The IRS postponed only the April 15 deadline to July 15.

March 13: The president declared a national emergency (Stafford Act), allowing the IRS to postpone tax filings/payments and to remove penalties and interest. Partnership and S-Corps are due March 16, so I hope the IRS acts fast! (See April 15 Tax Deadline.Might Get Coronavirus Relief)

Original blog post, dated February 27, 2020

March 16, 2020, is the deadline for filing 2019 S-Corp and partnership tax returns, or extensions, 2020 S-Corp elections for existing entities, and 2020 Section 475 elections for a pass-through entity. Don’t miss any of these tax filings or elections; it could cost you.

2019 S-Corp and partnership tax extensions
Extensions are easy to prepare and file for S-Corps and partnerships since they pass-through income and loss to the owner, usually an individual. Generally, pass-through entities are tax-filers, but not taxpayers.

For S-Corps and partnerships, use Form 7004 (Application for Automatic Extension of Time To File Certain Business Income Tax, Information, and Other Returns). 2019 S-Corp and partnership extensions give six additional months to file a federal tax return, by September 15, 2020.

Some states require a state extension filing, whereas others accept the federal extension. Some states have S-Corp franchise taxes, excise taxes, or minimum taxes, and payments are usually due with the extensions by March 16. LLCs filing as a partnership may have minimum taxes or annual reports due to the extension by March 16. States assess penalties and interest, often based on payments due.

See S-Corp 2019 Form 1120-S instructions, “Interest and Penalties” on page 4:

“Late filing of return. A penalty may be assessed if the return is filed after the due date (including extensions) or the return doesn’t show all the information required, unless each failure is due to reasonable cause. See Caution, earlier. For returns on which no tax is due, the penalty is $205 for each month or part of a month (up to 12 months) the return is late or doesn’t include the required information, multiplied by the total number of persons who were shareholders in the corporation during any part of the corporation’s tax year for which the return is due. If tax is due, the penalty is the amount stated above plus 5% of the unpaid tax for each month or part of a month the return is late, up to a maximum of 25% of the unpaid tax. The minimum penalty for a return that is more than 60 days late is the smaller of the tax due or $435.

Failure to furnish information timely. For each failure to furnish Schedule K-1 to a shareholder when due and each failure to include on Schedule K-1 all the information required to be shown (or the inclusion of incorrect information), a $270 penalty may be imposed. If the requirement to report correct information is intentionally disregarded, each $270 penalty is increased to $550 or, if greater, 10% of the aggregate amount of items required to be reported. The penalty won’t be imposed if the corporation can show that not furnishing information timely was due to reasonable cause. See Caution, earlier.

If the corporation receives a notice about penalties after it files its return, send the IRS an explanation and we will determine if the corporation meets reasonable-cause criteria. Don’t attach an explanation when the corporation’s return is filed.”

See partnership 2019 Form 1065 instructions, “Penalties” on page 6:

“Late Filing of Return. A penalty is assessed against the partnership if it is required to file a partnership return and it (a) fails to file the return by the due date, including extensions, or (b) files a return that fails to show all the information required, unless such failure is due to reasonable cause. The penalty is $205 for each month or part of a month (for a maximum of 12 months) the failure continues, multiplied by the total number of persons who were partners in the partnership during any part of the partnership’s tax year for which the return is due. If the partnership receives a notice about a penalty after it files the return, the partnership may send the IRS an explanation and the Service will determine if the explanation meets reasonable-cause criteria. Do not attach an explanation when filing the return.

Failure To Furnish Information Timely For each failure to furnish Schedule K-1 to a partner when due and each failure to include on Schedule K-1 all the information required to be shown (or the inclusion of incorrect information), a $270 penalty may be imposed for each Schedule K-1 for which a failure occurs. The maximum penalty is $3,339,000 for all such failures during a calendar year. If the requirement to report correct information is intentionally disregarded, each $270 penalty is increased to $550 or, if greater, 10% of the aggregate amount of items required to be reported. There is no limit to the amount of the penalty in the case of intentional disregard.”

2020 S-Corp elections

Traders qualifying for trader tax status (TTS) and interested in employee benefit plan deductions, including health insurance and retirement plan deductions, probably need an S-Corp. They should consider a 2020 S-Corp election on Form 2553 for an existing trading entity, due by March 16, 2020, or form a new company and file an S-Corp election within 75 days of inception. Most states accept the federal S-Corp election, but a few states do not; they require a separate S-Corp election filing by March 16. If you overlooked filing a 2019 S-Corp election by March 15, 2019 and intended to elect S-Corp tax treatment as of that date, you may qualify for IRS relief. (See Late Election Relief.) (Sole proprietor traders do not have self-employment income, which means they cannot have self-employed health insurance and retirement plan deductions. TTS partnerships face significant obstacles in achieving self-employment income.)

2020 Section 475 MTM elections for S-Corps and partnerships

Traders, eligible for TTS, should consider attaching a 2020 Section 475 election statement to their 2019 tax return or extension due by March 16, 2020, for partnerships and S-Corps, or by April 15, 2020, for individuals. Section 475 turns 2020 capital gains and losses into ordinary gains and losses, thereby avoiding the capital loss limitation and wash sale loss adjustments (tax loss insurance). Section 475 income, net of TTS expenses, is eligible for the “qualified business income” (QBI) deduction subject to taxable income limitations.

If a TTS partnership or S-Corp wants to revoke a prior year Section 475 election, a revocation election statement is due by March 16, 2020.

If you need help, consider a consultation.


How To Qualify For Substantial Tax Savings As A Trader

February 5, 2020 | By: Robert A. Green, CPA | Read it on

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

Business expenses include home-office, education, startup expenses, organization expenses, margin interest, tangible property expense, Section 179 (100%) or 100% bonus depreciation, amortization on software, self-created automated trading systems, seminars, market data, stock borrow fees, and much more. The new tax law TCJA suspended “certain miscellaneous itemized deductions subject to the 2% floor,” including investment fees and expenses, commencing in 2018.

Securities traders with TTS should consider a timely election of Section 475 ordinary gain or loss treatment; due by April 15, 2020, for individuals and March 16, 2020, for existing partnerships or S-Corps. I call it tax-loss insurance: It exempts securities trades from wash sale loss adjustments and the $3,000 capital loss limitation. Profitable 475 traders are eligible for the 20% qualified business income (QBI) deduction; whereas, QBI excludes capital gains and losses.

A TTS S-Corp unlocks deductions for health insurance premiums and high-deductible retirement plan contributions.

If a trader does not qualify for TTS, they are not eligible for any of these tax benefits.

How to qualify
It’s not easy to be eligible for TTS. Currently, there’s no statutory law with objective tests for eligibility. Subjective case law applies a two-part test:

  1. Taxpayers’ trading activity must be substantial, regular, frequent, and continuous.
  2. A taxpayer must seek to catch swings in daily market movements and profit from these short-term changes rather than profiting from long-term holding of investments.

Golden rules
Volume, frequency, and average holding period are the “big three” because they are more accessible for the IRS to verify.

Volume: The 2015 tax court case Poppe vs. Commission is a useful reference. Poppe made 720 total trades per year/60 per month. We recommend an average of four trades per day, four days per week, 16 trades per week, 60 a month, and 720 per year on an annualized basis. Count each open and closing trade separately, not round trip. Scaling in and out counts, too.

Frequency: Execute trades on close to four days per week, around a 75% frequency rate.

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

Trades full time or part-time, for a good portion of the day, almost every day the markets are open. Part-time and money-losing traders face more IRS scrutiny, and individuals face more scrutiny than entity traders.

Hours: Spends more than four hours per day, almost every market day working on his trading business — all-time counts.

Avoid sporadic lapses: A trader has few to no intermittent lapses in the trading business during the year.

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

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

Account size: Has a material account size. Securities traders need to have $25,000 on deposit with a U.S.-based broker to achieve “pattern day trader” (PDT) status. For the minimum account size, we like to see more than $15,000.

What doesn’t qualify?
Don’t count four types of trading activity for TTS qualification.

  1. Outside-developed automated trading systems. A computerized trading service (ATS) with little to no involvement by the trader doesn’t qualify for TTS. On the other hand, if the trader can show he’s very involved with the creation of the ATS — perhaps by writing the code or algorithms, setting the entry and exit signals, and turning over only execution to the program — the IRS may count the ATS-generated trades in the TTS analysis.
  2. Trade copying service. Some traders use “trade copying software” (TCS). Trade copying is similar to using a canned ATS or outside adviser, where the copycat trader might not qualify for TTS on those trades.
  3. Engaging a money manager. Hiring a registered investment adviser (RIA) or commodity trading adviser (CTA) — whether they are duly registered or exempt from registration — to trade one’s account doesn’t count toward TTS qualification.
  4. Trading retirement funds. Achieve TTS through trading in taxable accounts. Trading activity in non-taxable retirement accounts doesn’t count for purposes of TTS qualification.

For more in-depth information on TTS, see Green’s 2020 Trader Tax Guide Chapter 1 “Trader Tax Status.”

 


Highlights From Green’s 2020 Trader Tax Guide

January 7, 2020 | By: Robert A. Green, CPA | Read it on

 

Use Green’s 2020 Trader Tax Guide to receive every trader tax break you’re entitled to on your 2019 tax returns. Our 2020 guide covers the 2017 Tax Cuts and Jobs Act’s impact on investors, traders, and investment managers. Learn various smart moves to make in 2020.

Whether you prepare your 2019 tax returns as a trader or investor, this guide can help. Even though it may be too late for some tax breaks on 2019 tax returns, you can still use this guide to execute these tax strategies and elections for tax-year 2020.

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 for 2019 and 2020 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 and stock borrow fees.)

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.

2018 and 2019 tax forms

TCJA required significant revisions to the 2018 income tax forms. Some of those changes confused taxpayers, so the IRS revised the 2019 tax forms. The redesigned two-page 2018 Form 1040 resembled a postcard because the IRS moved many sections to six new 2018 Schedules (Form 1040). It was a block-building approach with the elimination of Form 1040-EZ and 1040-A.

The 2019 Form 1040 has three schedules, not six. The IRS moved some items back onto the Form 1040.

The IRS significantly changed Schedule A (Itemized Deductions). TCJA suspended “certain miscellaneous itemized deductions subject to the 2% floor.” These deductions were included in “Job Expenses and Certain Miscellaneous Deductions” on the 2017 Schedule A, lines 21 through 24. The revised 2018 Schedule A deleted these deductions, including job expenses, investment fees and expenses, and tax compliance fees and expenses.

The 2017 Schedule A also had “Other Miscellaneous Deductions,” not subject to the 2% floor, on line 28. That’s where investors reported stock-borrow fees, which are not investment fees and expenses. The 2018 Schedule A changed the name to “Other Itemized Deductions” on line 16.

TCJA introduced a new 20% deduction on qualified business income for 2018, but the IRS did not draft a tax form for it. Taxpayers used a worksheet for the calculation and reported a “qualified business income deduction” on the 2018 Form 1040, page 2, line 9. For 2019, the IRS introduced Form 8995 (Qualified Business Income Deduction Simplified Computation) and Form 8995-A (Qualified Business Income Deduction).

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 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 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.

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 (i.e., April 15, 2019 for 2019) 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 2019 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 April 15, 2019), 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, 2020, the 2020 business trading gains will be ordinary rather than capital. Remember, only capital gains can offset capital loss carryovers. That creates a predicament addressed in Chapter 2on 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 he or 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.

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 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 pairs, not minors.

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, and a net operating loss carries forward to subsequent tax year(s). TCJA’s “excess business loss” (EBL) limitation for 2019 is $510,000 married and $255,000 other taxpayers applies to Section 475 ordinary losses and trading expenses. Add an EBL to an NOL carryforward. See TCJA changes in Chapter 17.

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.

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 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.

Physical precious metals are collectibles; if these capital assets are held over 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 volatility exchange-traded notes (ETNs) and options on volatility 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 2020 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 $62,000 for 2019 and $63,500 for 2020 to a TTS S-Corp Solo 401(k) retirement plan generally saves traders significantly more in income taxes than it costs in 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: 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 $421,400/$210,700 (married/other taxpayers) for 2019, and $426,600/$213,300 (married/other taxpayers) for 2020. The phase-out range below the cap is $100,000/$50,000 (married/other taxpayers), in which the QBI deduction phases out for specified service activities. 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 and swap 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 $321,400/$160,700 (married/other taxpayers) for 2019, and $326,600/$163,300 (married/other taxpayers) for 2020. The IRS adjusts the annual TI income threshold for inflation each year. For more information, see Chapter 17.

Affordable Care Act

TCJA 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 and stock borrow fees. 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 2019 and 2020. 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, he or she has LTCG after one year on that interest. 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 “certain miscellaneous itemized deductions subject to the 2% floor,” which includes investment fees and expenses. Separately managed account investors are out of luck, but hedge fund investors can limit the negative impact by using carried-interest tax breaks. 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.

 


Execute S-Corp Officer Compensation With Employee Deductions Before Year-End

December 10, 2019 | By: Robert A. Green, CPA

TTS traders need an S-Corp trading company to arrange health insurance and retirement plan deductions. These deductions require earned income or self-employment income. Unlike trading gains, S-Corp salary is considered earned income.

The S-Corp must execute officer compensation, in conjunction with employee benefit deductions, through formal payroll tax compliance before the year-end 2019. Otherwise, traders miss the boat. TTS is an absolute must since an S-Corp investment company cannot have tax-deductible wages, health insurance, and retirement plan contributions. This S-Corp is not required to have “reasonable compensation” as other types of businesses are, so a TTS trader may determine officer compensation based on how much to reimburse for health insurance, and how much they want to contribute to a retirement plan. If you are in the QBI phase-out range, you might wish to have higher wages to increase a QBI deduction. For payroll tax compliance services, I recommend paychex.com; it has a dedicated team for our TTS S-Corp clients. Sole proprietor and partnership TTS traders cannot pay salaries to 2% or more owners.

TTS S-Corps may only deduct health insurance for the months the S-Corp was operational and qualified for TTS. Employer-provided health insurance, including Cobra, is not deductible. It doesn’t need to be profitable for the health insurance deduction.

A taxpayer can deduct a contribution to a health savings account (HSA) without TTS or earned income. HSA contribution limits for 2019 are $3,500 individual and $7,100 for family coverage. There’s an additional $1,000 for age 55 or older. Some employers offer a flexible spending account (FSA) for covering health care copayments, deductibles, some drugs, and other health care costs. Both HSAs and FSAs must be fully funded and utilized before the year-end.

TTS S-Corps formed later in the year can unlock a retirement plan deduction by paying sufficient officer compensation in December when results for the year are evident. Traders should only fund a retirement plan from trading income, not losses.

You must open a Solo 401(k) retirement plan for a TTS S-Corp with a financial intermediary before the year-end 2019. Plan to pay the 2019 100%-deductible elective deferral amount up to a maximum of $19,000 (or $25,000 if age 50 or older) with December payroll. That elective deferral is due by the end of January 2020. You can fund the 25% profit-sharing plan (PSP) portion of the S-Corp Solo 401(k) up to a maximum of $37,000 by the due date of the 2019 S-Corp tax return, including extensions, which means Sept. 15, 2020. The maximum PSP contribution requires wages of $148,000 ($37,000 divided by 25% defined contribution rate). Tax planning calculations will show the projected outcome of income tax savings vs. payroll tax costs for the various options.

Consider a Solo 401(k) Roth, where the contribution is not deductible, but the contribution and growth within the Roth are permanently tax-free. Traditional plans have a tax deduction upfront, and all distributions are subject to ordinary income taxes in retirement. Traditional retirement plans have required minimum distributions (RMD) by age 70½, whereas Roth plans don’t have RMD.

Setting up a TTS S-Corp for 2020
If you missed out on employee benefits in 2019, then consider an LLC with S-Corp election for 2020. You can form a single-member LLC by mid-December 2019, obtain the employee identification number (EIN), and open the LLC brokerage account before year-end to begin trading in it on Jan. 1, 2020. The single-member LLC is a disregarded entity for 2019, which avoids an entity tax return filing for the 2019 partial year. A spouse can be added as a member of the LLC on Jan. 1, 2020, which means the LLC will file a partnership return for 2020. If you want health insurance and retirement plan deductions, then your single-member or spousal-member LLC should submit a 2020 S-Corp election within 75-days of Jan. 1, 2020. The S-Corp should also consider making a Section 475 MTM election on securities only for 2020 within 75 days of Jan. 1, 2020.

Clients of our firm GNM should sign up for S-Corp Tax Compliance (Traders) and work with their assigned CPA before the year-end.

If you want to set up an LLC in December with S-Corp election for 2020, start with a 45-minute paid consultation with Robert A. Green, CPA. You can purchase our entity formation service afterward.


Tax Planning At Year-End Generates The Most Savings

October 26, 2019 | By: Robert A. Green, CPA | Read it on

The best way to reduce income taxes is with year-end tax planning. Don’t wait until February when you begin preparation of 2019 tax returns; that’s too late for many tax savings strategies.

If you have an S-Corp that is eligible for trader tax status (TTS), don’t miss that section further down below, which includes essential year-end transactions, including formal payroll tax compliance for officer compensation. That unlocks the health insurance and or retirement plan deductions.

Defer income and accelerate tax deductions
Consider the time-honored strategy of deferring income and accelerating tax deductions if you don’t expect your taxable income to decline in 2020. We expect tax rates to be the same for 2020, although the IRS will adjust the tax brackets for inflation. Enjoy the time-value of money with income deferral.

Year-end tax planning is a challenge for traders because they have wide fluctuations in trading results, making it difficult to forecast their income. Those expecting to be in a lower tax bracket in 2020 should consider income deferral strategies. Conversely, a 2019 TTS trader with ordinary losses, waiting to be in a higher tax bracket in 2020, might want to consider income acceleration strategies.

Taxpayers with trader tax status in 2019 should consider accelerating trading business expenses, such as purchasing business equipment with full expensing.

Don’t assume that accelerating itemized deductions is also a smart move; there may be two problems. TCJA suspended and curtailed various itemized deductions after 2017, so there is no sense in expediting a non-deductible item. Even with the acceleration of deductible expenses, many taxpayers will be better off using the 2019 standard deduction of $24,400 married or $12,200 single. If itemized deductions are below the standard deduction, consider a strategy to “bunch” them into one year and take the standard deduction in other years.

Accelerate income and defer certain deductions
A TTS trader with substantial ordinary losses (Section 475) under the “excess business loss limitation” (EBL, see below) should consider accelerating income to soak up the allowable business loss, instead of having an NOL carryover. Try to advance enough income to use the standard deduction and take advantage of lower tax brackets. Be sure to stay below the thresholds for unlocking various types of AGI-dependent deductions and credits.

Roth IRA conversion: Convert a traditional IRA into a Roth IRA before year-end to accelerate income. The conversion income is taxable in 2019, but the 10% excise tax on early withdrawals before age 59½ is avoided providing you pay the conversion taxes from outside the Roth plan. One concern is that TCJA repealed the recharacterization option; you can no longer reverse it if the plan assets decline after conversion. There isn’t an income limit for making Roth IRA conversions, whereas there is for making regular Roth IRA contributions. For example, a taxpayer filing single has a $405,000 TTS/475 ordinary loss. However, the excess business loss limitation is $255,000, and $150,000 is an NOL carryover. Consider a Roth conversion to soak up most of the $255,000 allowed business loss, and leave enough income to use the standard deduction and lower tax brackets.

Sell winning positions: Another way a trader can accelerate income is to sell open winning positions to realize capital gains.

Consider selling long-term capital gain positions. The 2019 long-term capital gains rates are 0% for taxable income under $39,375 single, and $78,750 married filing jointly. The 15% capital gains rate applies to taxable income up to $434,550 for filing single and $488,850 married filing jointly. The top bracket rate of 20% applies above those amounts.

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

Business expenses and itemized deduction vs. standard deduction

Business expenses: TTS traders are entitled to deduct business expenses and home-office deductions from gross income. The home office deduction requires income, except for the mortgage interest and real property tax portion. The SALT cap on state and local taxes does not apply to the home office deduction. TCJA expanded full expensing of business property; traders can deduct 100% of these costs in the year of acquisition, providing they place the item into service before year-end. If you have TTS in 2019, considering going on a shopping spree before January 1. There is no sense deferring TTS expenses because you cannot be sure you will qualify for TTS in 2020.

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

Unreimbursed partnership expenses: Partners in LLCs taxed as partnerships can deduct unreimbursed partnership expenses (UPE). That is how they usually deduct home office expenses. UPE is more convenient than using an S-Corp accountable plan because the partner can arrange the UPE after the year-end. The IRS doesn’t want S-Corps to use UPE.

SALT cap: TCJA’s most contentious provision was capping state and local income, sales, and property taxes (SALT) at $10,000 per year ($5,000 for married filing separately) – and not indexing it for inflation. Many high-tax states continue to contest the SALT cap, but they haven’t prevailed in court. The IRS reinforced the new law by blocking various states’ attempts to recast SALT payments as charitable contributions, or payroll tax as a business expense. Stay tuned to news updates about SALT.

Investment fees and expenses: TCJA suspended all miscellaneous itemized deductions subject to the 2% floor, which includes investment fees and expenses. TCJA left just two itemized deductions for investors: Investment-interest expenses limited to investment income, with the excess as a carryover, and stock borrow fees for short-sellers.

Standard deduction: TCJA roughly doubled the 2018 standard deduction and suspended and curtailed several itemized deductions. The 2019 standard deduction is $12,200 single, $24,400 married, and $18,350 head of household. There is an additional standard deduction of $1,300 for the aged or the blind. Many more taxpayers will use the standard deduction, which might simplify their tax compliance work. For convenience sake, some taxpayers may feel inclined to stop tracking itemized deductions because they figure they will use the standard deduction. Don’t overlook the impact of these deductions on state tax filings where you might get some tax relief for itemizing deductions.

Estimated income taxes and AMT

Estimated income taxes: If you already reached the SALT cap, you don’t need to prepay 2019 state estimated income taxes by December 31, 2019. Pay federal and state estimated taxes owed when due by January 15, 2020, with the balance of your tax liabilities payable by April 15, 2020. You can gain six months of additional time by filing an automatic extension on time, but late-payment penalties and interest will apply on any tax balance due. (See Tax Extensions: 12 Tips To Save You Money.)

Many traders skip making quarterly estimated tax payments during the year, figuring they might incur trading losses later in the year. Catch up with the Q4 estimate due by January 15. Some rely on the safe harbor exception to cover their prior year taxes. TTS S-Corp traders should consider withholding additional taxes on year-end paychecks in connection with retirement plan contributions, which helps avoid underestimated tax penalties since the IRS treats wage withholding as being made throughout the year.

AMT: In prior years, taxpayers had to figure out how much they could prepay their state without triggering alternative minimum tax (AMT) since state taxes are not deductible for AMT taxable income. It’s easier in 2019 with SALT capped at $10,000 and because TCJA raised the 2019 AMT exemptions to $510,300 single and $1,020,600 married filing jointly. Taxpayers subject to AMT should not accelerate AMT preference items.

Avoid wash sale loss adjustments

Wash sales: Taxpayers must report wash sale (WS) loss adjustments on securities based on substantially identical positions across all accounts, including IRAs. Conversely, brokers assess WS only on identical positions per the one account. Active securities traders should use a trade accounting program or service to identify potential WS loss problems, especially going into year-end.

In taxable accounts, a trader can break the chain by selling the position before year-end and not repurchasing a substantially identical position 30 days before or after in any of his taxable or IRA accounts. Avoid WS between taxable and IRA accounts throughout the year, as that is otherwise a permanent WS loss. (Starting a new entity effective January 1, 2020, can break the chain on individual account WS at year-end 2019 provided you don’t purposely avoid WS with the related party entity.)

WS losses might be preferable to capital loss carryovers at year-end 2019 for TTS traders. A Section 475 election in 2020 converts year-end 2019 WS losses on TTS positions (not investment positions) into ordinary losses in 2020. That’s better than a capital loss carryover into 2020, which might give you pause to making a Section 475 election. You want a clean slate with no remaining capital losses before electing Section 475 ordinary income and loss. (See How To Avoid Taxes On Wash Sale Losses.)

Trader tax status and Section 475

Trader tax status: If you qualify for TTS (business expense treatment — no election needed) in 2019, accelerate trading expenses into that qualification period as a sole proprietor or entity. If you don’t qualify until 2020, try to defer trading expenses until then. You may also capitalize and amortize (expense) Section 195 startup costs and Section 248 organization costs in the new TTS business, going back six months before commencement. TTS is a prerequisite for electing and using Section 475 MTM. (See How Traders Get Enormous Tax Deductions, And Investors Do Not.)

Section 475 MTM: TTS traders choose Section 475 on securities for exemption from wash-sale loss rules and the $3,000 capital loss limitation — and to be eligible for the 20% QBI deduction. To make a 2019 Section 475 election, existing individual taxpayers had to file an election statement with the IRS by April 15, 2019 (March 15 for existing S-Corps and partnerships). If they filed that election statement on time, they need to complete the election process by submitting a 2019 Form 3115 with their 2019 tax return. Those who missed the 2019 election deadline may want to consider the election for 2020. Capital loss carryovers are a concern; use them up against capital gains but not Section 475 ordinary income. Once you make a 475 election, it remains in effect; you don’t have to elect it every year. You are entitled to revoke a 475 election, in the same manner, you elect it. If you stop qualifying for TTS, then 475 treatment is suspended until you requalify.

If you make a Section 475 election by April 15, 2020, it takes effect on January 1, 2020. In converting from the realization (cash) method to the mark-to-market (MTM) method, you need to make a Section 481(a) adjustment on January 1, 2020. It’s unrealized capital gains, and losses on open TTS securities positions held on December 31, 2019. Do not apply Section 475 to investment positions. If you are not a TTS trader as of year-end 2019, then you won’t have a Section 481(a) adjustment. (See Section 481(a) Positive Adjustment Spread Period Changes.)

A “new taxpayer” entity can elect Section 475 within 75 days of inception. That would come in handy if you missed the individual sole proprietor deadline (April 15, 2019) for choosing Section 475. Forming a new entity on November 1, 2019, or later, is too late for establishing TTS for the 2019 short calendar year. Consider waiting until January 1, 2020, for starting a new entity with TTS and electing Section 475.

20% deduction on qualified business income
In August 2018, the IRS issued proposed reliance regulations (Proposed §1.199A) for the TCJA’s 20% deduction on qualified business income (QBI) in pass-through entities. On January 18, 2019, the IRS issued the final 199A regs. The proposed and final regulations confirm that 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 2019 taxable income (TI) cap is $421,400/$210,700 (married/other taxpayers). The phase-out range below the cap is $100,000/$50,000 (married/other taxpayers), in which the QBI deduction phases out for specified service activities. The W-2 wage and property basis limitations also apply within the phase-out range. Investment managers are specified service activities, too.

QBI includes Section 475 ordinary income and loss, and trading business expenses. QBI excluded capital gains and losses, Section 988 forex and swap ordinary income or loss, dividends, and interest income. Our firm took a favorable position on QBI for traders. (See A Rationale For Using QBI Tax Treatment For Traders.)

TCJA favors non-service businesses, which are not subject to an income cap. The W-2 wage and property basis limitations apply above the 2019 TI threshold of $321,400/$160,700 (married/other taxpayers). The IRS adjusts the annual TI income threshold for inflation each year.

Taxpayers might be able to increase the QBI deduction with smart year-end planning. If taxable income falls within the phase-out range for a specified service activity, or even above for a non-service business, you might need higher wages, including officer compensation, to avoid a W-2 wage limitation on the QBI deduction. Deferring income can also help get under various QBI restrictions and thresholds.

Net operating losses and the Section 1256 loss carryback election

Net operating losses: Section 475 ordinary losses and TTS business expenses contribute to net operating loss (NOL) carryforwards, which are limited to 80% of taxable income in the subsequent year(s). Get immediate use of some or all of NOLs with a Roth IRA conversion before year-end and other income acceleration strategies. TCJA repealed NOL carrybacks after 2017 with one exception; farmers may carry back an NOL two tax years. TCJA made NOL carryforwards unlimited, changing the carryforward period from 20 years. Repealing NOL carrybacks negatively impacts TTS traders using 475 ordinary loss treatment. We helped traders obtain significant NOL refunds before 2018, which helped them remain in business. An “excess business loss” (EBL) over the limitation is an NOL carryforward, and accelerating non-business income won’t avoid EBL. (See EBL below.)

Section 1256 loss carryback election: The only remaining carryback for traders is a Section 1256 loss carryback to the prior three tax years, offset against 1256 gains, not other types of income. Any loss remaining is carried forward. Consider making a Section 1256 loss carryback election on a 2019 Form 6781 timely filed with a 2019 tax return.

There are other tax advantages to trading Section 1256 contracts. They have lower 60/40 capital gains tax rates, meaning 60% (including day trades) use the lower long-term capital gains rate, and 40% use the short-term rate, which is the ordinary tax rate. At the maximum tax brackets for 2019, the top Section 1256 contract tax rate is 26.8% —10.2% lower than the highest ordinary rate of 37%. Section 1256 tax rates are 4.2% to 12% lower vs. ordinary rates depending on which tax bracket applies. Section 1256 contracts are marked-to-market (MTM), so you don’t have to do tax-loss selling at year-end. (See Trading Futures & Other Section 1256 Contracts Has Tax Advantages.)

Limitations on excess business losses and business interest expense

Excess business loss limitation: TCJA included an “excess business loss” (EBL) limitation of $500,000/$250,000 (married/other taxpayers) for 2018. (The 2019 inflation-adjusted limit is $510,000/$255,000 (married/other taxpayers). Aggregate EBL from all pass-through businesses: A profitable company can offset another business with losses to remain under the limit. Include wage income in aggregate EBL. Other types of income and non-business losses do not affect the EBL calculation (i.e., capital gains and losses). EBL over the limit is an NOL carryforward.

Example of EBL limitation: TTS/475 trader filing single has an ordinary loss of $500,000 for 2019. It’s considered a business loss. He has income from wages of $100,000, so his net EBL is $400,000. The 2019 EBL limitation is $255,000 and the 2019 NOL carryover to 2020 is $145,000 ($400,000 minus $255,000).

Business interest expense: TCJA introduced a limitation on deducting business interest expense in Section 163(j). The 30% limitation should not impact most TTS traders because the $25 million three-year average “gross receipts” threshold applies to net trading gains, not proceeds. That’s good news because if gross receipts used total sales proceeds on trades, then a TTS trader with trading losses might have a business interest expense limitation. With net trading gains being the standard, only more substantial hedge funds might be impacted.

S-Corp officer compensation, health insurance, and retirement plan deductions
TTS traders need an S-Corp trading company to arrange health insurance and retirement plan deductions. These deductions require earned income or self-employment income, and trading gains are not that. S-Corp salary is considered earned income.

2019 S-Corp: The S-Corp must execute officer compensation, in conjunction with employee benefit deductions, through formal payroll tax compliance before the year-end 2019. Otherwise, traders miss the boat. TTS is an absolute must since an S-Corp investment company cannot have tax-deductible wages, health insurance, and retirement plan contributions. This S-Corp is not required to have “reasonable compensation” as other types of businesses are, so a TTS trader may determine officer compensation based on how much to reimburse for health insurance, and how much they want to contribute to a retirement plan. Keep an eye out for the QBI deduction; if you are in the QBI phase-out range, you might wish to have higher wages to increase a QBI deduction. For payroll tax compliance services, I recommend paychex.com; they have a dedicated team for our TTS S-Corp clients. Sole proprietor and partnership TTS traders cannot pay salaries to 2% or more owners.

Health insurance deduction: A TTS S-Corp may only deduct health insurance for the months the S-Corp was operational and qualified for TTS. Employer-provided health insurance, including Cobra, is not deductible. A TTS S-Corp doesn’t need to be profitable for the health insurance deduction.

Health Savings Account: A taxpayer can deduct a contribution to a health savings account (HSA) without needing TTS eligibility or earned income. HSA contribution limits for 2019 are $3,500 individual and $7,100 for family coverage. There’s an additional $1,000 for age 55 or older. Fully fund and utilize the HSA before year-end.

Flexible Spending Account: Some employers offer a flexible spending account (FSA) for covering health care copayments, deductibles, some drugs, and other health care costs. Fully fund and utilize the FSA before year-end.

Solo 401(k) retirement plan: A TTS S-Corp formed later in the year can unlock a retirement plan deduction for an entire year by paying sufficient officer compensation in December when results for the year are evident. Traders should only fund a retirement plan from trading income, not losses.

You must establish (open) a Solo 401(k) retirement plan for a TTS S-Corp with a financial intermediary before the year-end 2019. Plan to pay the 2019 100%-deductible elective deferral amount up to a maximum of $19,000 (or $25,000 if age 50 or older) with December payroll. That elective deferral is due by the end of January 2020. You can fund the 25% profit-sharing plan (PSP) portion of the S-Corp Solo 401(k) up to a maximum of $37,000 by the due date of the 2019 S-Corp tax return, including extensions, which means September 15, 2020. The maximum PSP contribution requires wages of $148,000 ($37,000 divided by 25% defined contribution rate). Do tax planning calculations to see the projected outcome of income tax savings vs. payroll tax costs for the various options.

Consider a Solo 401(k) Roth, where the contribution is not deductible, but the contribution and growth within the Roth are permanently tax-free. Traditional plans have a tax deduction upfront, and all distributions are subject to ordinary income taxes in retirement. Traditional retirement plans have required minimum distributions (RMD) by age 70 ½, whereas Roth plans don’t have RMD.

Setting up a TTS S-Corp for 2020
If you missed out on employee benefits in 2019, then consider an LLC with S-Corp election for 2020. If you wait to start your entity formation process on January 1, 2020, you won’t be ready to trade in an entity account on January 1, 2020. Instead, you can form a single-member LLC by mid-December 2019, obtain the employee identification number (EIN), and open the LLC brokerage account before year-end. The single-member LLC is a disregarded entity for 2019, which avoids an entity tax return filing for the 2019 partial year. If desired, add your spouse as a member of the LLC on January 1, 2020, which means the LLC will file a partnership return. If you want health insurance and retirement plan deductions, then your single-member or spousal-member LLC should submit a 2020 S-Corp election by March 15, 2020. The S-Corp should also consider making a Section 475 MTM election on securities only for 2020 by March 15.

Tax-loss selling of financial instruments
If you own an investment or trading portfolio, you have the opportunity to reduce capital gains taxes via “tax-loss selling.” If you realized significant short-term capital gains year-to-date in 2019 and have open positions with substantial unrealized capital losses, you should consider selling (realizing) some of those losses to reduce 2019 capital gains taxes. Don’t repurchase the losing position 30 days before or after, as that would negate the tax loss with wash-sale loss rules.

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

Tax-loss selling is inefficient for short-term positions that reduce long-term capital gains. It’s also a moot point with Section 1256 and Section 475 positions since they are mark-to-market positions reporting realized and unrealized gains and losses.

Married couples should compare filing joint vs. separate
Each year, married couples choose between “married filing jointly” (MFJ) vs. “married filing separately” (MFS). TCJA fixed several inequities in filing status, including the tax brackets by making single, MFJ and MFS equivalent, except for divergence at the top rate of 37% for single filers, retaining some of the marriage penalty. There are other issues to consider, too.

Married couples may be able to improve QBI deductions, AGI, and other income-threshold dependent deductions, and credits with MFS in 2019. It’s wise to enter each spouse’s income, gain, loss, and expense separately and have the tax planning and preparation software compare MFJ vs. MFS. In a community property state, there are special rules for allocating income between spouses.

Filing MFS might unlock a QBI deduction, where one spouse might price the other spouse out of a QBI deduction based on exceeding the income cap for a specified service activity.

Miscellaneous considerations for individuals
Sell off passive-loss activities to utilize suspended passive-activity losses.

Maximize contributions to retirement plans. That lowers AGI and other income thresholds, which can unlock more of a QBI deduction, reduce net investment tax, and unlock credits and other tax benefits. Consider non-deductible IRA contributions.

The IRS has many obstacles to deferring income, including passive-activity loss rules, a requirement that certain taxpayers use the accrual method of accounting and limitations on charitable contributions. TCJA allows more businesses to use the cash method.

Consider a charitable remainder trust to bunch philanthropic contributions for itemizing deductions. (Ask Fidelity or Schwab about it.)

Donate appreciated securities to charity: You get a charitable deduction at the FMV and avoid capital gains taxes. (This is a favorite strategy by billionaires, and you can use it, too.)

Retirees must take required minimum distributions (RMD) by age 70½ unless it’s a Roth IRA. Per TCJA, consider directing your traditional retirement plan to make “qualified charitable distributions” (QCD). That satisfies the RMD rule with the equivalent of an offsetting charitable deduction, allowing you to take the standard deduction rather than itemize charitable contributions.

TCJA improves family tax planning: Section 529 qualified tuition plans now can be used to pay for tuition at an elementary or secondary public, private or religious school, up to $10,000 per year (check with your state). The 2019 annual gift exclusion is $15,000, and its $155,000 to noncitizen spouses; the 2019 unified credit for federal estate tax is $11.40 million per person, and “step-up in basis” rules still avoid capital gains taxes on inherited appreciated property. TTS traders should also consider hiring adult children as employees. (See How To Save Taxes With Children.)

TCJA created Qualified Opportunity Zones (QOZ) “to spur economic development and job creation in distressed communities throughout the country and U.S. possessions by providing tax benefits to investors who invest eligible capital into these communities. Taxpayers may defer tax on eligible capital gains by making an appropriate investment in a Qualified Opportunity Fund and meeting other requirements,” per Opportunity Zones Frequently Asked Questions.)

Adam Manning CPA contributed to this blog post. 

This blog post is an updated version of chapter 9 on tax planning in Green’s 2019 Trader Tax GuideFree upgrade: If you purchase Green’s 2019 Trader Tax Guide after October 15, 2019, we will email you online access to Green’s 2020 Trader Tax Guide around the middle of January 2020.

Our CPAs are standing by in November and December to help clients with 2019 year-end tax planning. Our tax compliance service includes tax planning and preparation, and we look forward to helping you execute the above tax strategies. Please contact us soon.

Consider a 45-minute consultation with Robert A. Green, CPA to discuss eligibility for TTS and if an entity if helpful to you. Upgrade to our entity formation service after, if warranted.

Join my upcoming Webinar on November 13, 2019, or watch the recording after to learn more about this content: Tax Planning At Year-End Generates The Most Savings

 

 


How To Save Taxes With Children

October 8, 2019 | By: Robert A. Green, CPA

Children are lovely, but they also cost a lot of money on childcare and education costs. With careful tax planning, you can generate significant tax savings.

Consider shifting a portion of investment income from the parent’s tax return to the children. However, avoid having too high unearned income for younger children as that might trigger the “kiddie tax,” which defeats the intended purpose. (See below: The “kiddie tax” rules and how they affect you.)

If you have a family business, consider hiring your children to shift earned income to the children’s lower tax brackets. For sole proprietorships and LLC/partnerships, you might also save social security taxes. (See below: Tax benefits of putting junior family members on the payroll.)

There is a litany of tax planning strategies to consider while saving for education, including college. These include qualified tuition programs (“529 plans”), tax-exempt bonds, Coverdell education savings accounts, tuition tax credits, employer educational assistance programs, college expense payments by grandparents and others, the student loan interest deduction, borrowing against retirement plan accounts, and withdrawals from retirement plan accounts. (See below: Tax planning for college, and Qualified tuition programs-”529 plans”)

As a working parent, you might qualify for the dependent care credit or an employer-provided dependent care flexible spending account (FSA). Determine which one is better for your tax bracket and needs. (See below: Dependent care credit/dependent care flexible spending account.)

The new tax law, TCJA, made the child tax credit (CTC) more valuable, and more taxpayers should qualify for this credit. (See below: Child tax credit.)

Client Letters from Thomson Reuters/Tax & Accounting:

  • The “kiddie tax” rules and how they affect you (page 3)
  • Tax benefits of putting junior family members on the payroll (page 5)
  • Tax planning for college (page 7)
  • Qualified tuition programs-”529 plans” (page 14)
  • Dependent care credit/dependent care flexible spending account (page 16)
  • Child tax credit (page 20)

We are emailing a PDF file containing the above Client Letters, so sign up for our Email List.

If you would like to discuss any of these tax planning strategies, contact your assigned CPA in our firm, or consider a consultation. Contact us with any questions.

Thank you,

Robert A. Green, CPA
CEO, GreenTraderTax.com
Managing Member, Green, Neuschwander & Manning, LLC

 


What You Trade Can Make A World Of Tax Difference

September 29, 2019 | By: Robert A. Green, CPA | Read it on

There’s a bevy of financial products to trade with a wide assortment of tax treatment. Traders have access to U.S. and international equities, futures and other Section 1256 contracts, options, ETFs, ETNs, forex, precious metals, foreign futures, cryptocurrencies, and swap contracts. Broker-issued Form 1099-Bs might not provide the best available tax treatment, and in some cases, there are no 1099s issued.

Securities
Securities traders have ordinary tax rates on short-term capital gains, wash sale loss adjustments, capital-loss limitations, and accounting challenges.

Securities include:
- U.S. and international equities (stocks)
- U.S. and foreign equity (stock) options
- narrow-based indexes (an index made up of nine or fewer securities)
- options on narrow-based indexes
- securities ETFs structured as registered investment companies (RIC)
- options on securities ETF RICs
- commodities ETFs structured as publicly traded partnerships (PTP)
- volatility ETNs, structured as debt instruments
- bonds
- mutual funds
- single-stock futures

Securities don’t include:
- Section 1256 contracts
- precious metals (collectibles)
- ETFs structured as publicly traded trusts (PTT)
- CBOE-listed options on ETF PTPs and ETF PTTs
- CBOE-listed options on ETNs
- volatility ETNs structured as prepaid forward contracts (PFC)
- cryptocurrencies (intangible property)
- forex (spot and forwards contracts)
- swap contracts

The IRS taxes securities transactions when a taxpayer closes an open trade – hence the term “realization method.” Taxpayers can defer capital gains by holding open securities positions at year-end.

With “tax-loss selling,” investors realize losses before year-end. Be careful not to re-enter those positions within 31 days; otherwise, the planned tax loss might defer to 2020 as a wash sale loss adjustment.

Short-term capital gains (STCG) use ordinary tax rates, currently up to 37% for 2019 and 2020. Long-term capital gains (LTCG) rates are significantly lower, and they apply to sales of securities held for 12 months or more. The LTCG rates are 0% for the 10% and 12% ordinary brackets, 15% in the middle brackets, and 20% in the top 37% bracket. (See 2019 Tax Brackets.)

The mark-to-market (MTM) accounting method is different. MTM taxes realized and unrealized capital gains and losses at year-end. Traders eligible for trader tax status (TTS) are entitled to elect Section 475 MTM ordinary gain or loss on securities and or commodities. (See How Traders Get Enormous Tax Deductions, And Investors Do Not.) Section 1256 contracts have MTM by default. (See 1256 contracts below).

Capital losses, including capital loss carryovers, offset capital gains without a limitation. A net capital loss for the year is limited to $3,000 against other income like wages. Capital loss carryovers don’t expire; they are deferred tax assets. If you have excess capital losses, don’t rush to elect Section 475 ordinary income as you need capital gains to use up capital losses. Look at all sources of capital gains, including sales of real property and intangible property. Trading entities and hedge funds can pass capital gains to the owner’s tax return.

Section 1256 Contracts
Section 1256 contracts enjoy lower 60/40 capital gains tax rates, summary tax reporting, and easier mark-to-market accounting.

Section 1256 contracts include:
- U.S. regulated futures contracts (RFCs)
- options on U.S. RFCs
- U.S. broad-based indexes made up of 10 or more underlying securities – also known as stock index futures
- options on U.S. broad-based indexes
- foreign futures if granted Section 1256 treatment in an IRS revenue ruling (see list)
- non-equity options (a catchall)
- CBOE-listed options on commodity ETF publicly traded partnerships (PTP)
- CBOE-listed options on precious metals ETF publicly traded trusts (PTT)
- CBOE-listed options on volatility ETN prepaid forward contracts and ETN debt instruments
- forward forex contracts with the opt-out election into Section 1256(g) on the major pairs, for which futures trade (we make a case for spot forex, too)
- forex OTC options (Wright court)

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 2019 and 2020, the blended 60/40 rate is 26.8% — 10.2% lower than the highest ordinary bracket of 37%. There are significant tax savings throughout the income brackets. The LTCG rate in the lowest two ordinary brackets is 0%. (See our table Section 1256 tax rates vs. ordinary rates.)

Section 1256 contracts are marked-to-market (MTM) daily. For tax purposes, MTM reports both realized activity from throughout the year and unrealized gains and losses on open trading positions at year-end. The 1099-B is one page with summary reporting.

There is a Section 1256 loss carryback election. Rather than use the 1256 loss in the current year, deduct 1256 losses on amended tax return filings, applied against Section 1256 gains only. Form 1045 is better than 1040X. It’s a three-year carryback; unused amounts carry forward. TCJA repealed most NOL carrybacks, so this is the only remaining carryback opportunity for traders. (See Trading Futures & Other Section 1256 Contracts Has Tax Advantages.)

Options
Tax treatment for options is diverse, including simple (outright) and complex trades with multiple legs.

Options taxed as securities:
- equity (stock) options
- options on narrow-based indexes
- options on securities ETFs RIC

Options taxed as 1256 contracts:
- non-equity options (a catchall)
- options on U.S. regulated futures contracts and broad-based indexes
- CBOE-listed options on commodity ETF publicly traded partnerships (PTP)
- CBOE-listed options on precious metals ETF publicly traded trusts (PTT)
- CBOE-listed options on volatility ETN prepaid forward contracts and ETN debt instruments
- forex OTC options (Wright appeals court)

Generally, options listed on a commodities exchange, a qualified board or exchange (QBE), are a 1256 contract unless the reference is a single stock or a narrow-based stock index. A securities ETF RIC is like a stock in this regard.

Three things can happen with outright option trades:

- Trade option (closing transaction).
- The option expires (lapses).
- Exercise the option.

There are special rules for the holding period for long-term capital gains. (See Tax Treatment Can Be Tricky With Options and ETFs.)

Exchange-Traded Funds (ETF)
Securities, commodities, and precious metals ETFs use different structures, and tax treatment varies.

Securities ETFs: Securities ETFs are registered investment companies (RICs). Selling a securities ETF is deemed a sale of a security, calling for short-term and long-term capital gains tax treatment on the realization method. As a security, wash sale loss adjustments or Section 475 apply if elected.

Commodities ETFs: Commodities ETFs use the publicly traded partnership (PTP) structure. PTPs issue annual Schedule K-1s passing through Section 1256 tax treatment on Section 1256 transactions to investors, as well as other taxable items. Selling a commodity ETF is deemed a sale of a security, calling for short-term and long-term capital gains tax treatment using the realization method. It’s a security, so it’s subject to WS losses and a 475 election if elected.

Taxpayers invested in commodities ETFs should adjust cost-basis on Form 8949 (capital gains and losses). That ensures they don’t double count Schedule K-1 pass-through income or loss. Form 1099-B and trade accounting software do not make this adjustment, so you need to make a manual adjustment.

Physically backed precious metals ETFs: They usually choose the publicly traded trust (PTT) structure (also known as a grantor trust). A PTT issues an annual Schedule K-1, passing through tax treatment to the investor, which in this case is the “collectibles” rate on sales of physically-backed precious metals (such as gold bullion). Selling a precious metal ETF is deemed disposition of a precious metal, which is a collectible. For collectibles held over one year (long-term), sales use the “collectibles” rate —capped at 28%. Short-term capital gains use the ordinary rate. Precious metals and ETFs backed by precious metals are not securities, so they are not subject to WS loss adjustments, or Section 475 if elected.

Forex
Forex transactions start off receiving an ordinary gain or loss treatment, as dictated by Section 988 (foreign currency transactions). Ordinary losses are generally better than capital losses, providing the trader has other income to absorb the loss. With eligibility for TTS, an excess ordinary business loss is a net operating loss (NOL) carryforward.

Section 988 allows traders to file a capital gains election to opt-out of Section 988 ordinary treatment. It must be done contemporaneously in your books and records. You can make, or retract, the opt-out election on a “good to cancel” basis at any time during the year. If you have a capital loss carryover, then consider a capital gains election.

The capital gains election on forex forwards allows the trader to use lower 60/40 capital gains rates in Section 1256(g). There are two requirements: It must be on “major currencies,” and the trader must not take or make delivery. “Major currencies” means currency pairs, which also trade as futures on U.S. commodities exchanges. We make a case for including “spot” forex in Section 1256(g). (See A Case For Retail Forex Traders Using Section 1256(g) Lower 60/40 Tax Rates.)

Foreign futures
By default, futures contracts listed on international exchanges are not Section 1256 contracts. If the international exchange wants Section 1256 tax treatment, they must obtain an IRS Revenue Ruling granting 1256 treatment. Only a handful of international futures exchanges have Section 1256 treatment: Eurex, LIFFE, ICE Futures Europe, and ICE Futures Canada. Foreign futures are otherwise ST or LT capital gains. (See Tax treatment for foreign futures.)

Precious metals
Physical precious metals are “collectibles,” which are a particular class of capital assets. If you hold collectibles over one year (long-term), sales are taxed at the “collectibles” tax rate — capped at 28%. (If your ordinary rate is lower, use that.) If you hold collectibles one year or less, the short-term capital gains ordinary tax rate applies no different from the regular STCG tax rate.

Volatility products
There are many different types of volatility-based financial products to trade, and tax treatment varies.

CBOE Volatility Index (VIX) futures are Section 1256 contracts with lower 60/40 MTM tax rates. The NYSE-traded SVXY is an exchange-traded fund (ETF), taxed as a security. The iPath S&P 500 VIX Short-Term Futures (VXX) is an exchange-traded note (ETN).

Volatility ETNs. Many issuers structure volatility ETNs as prepaid forward contracts (PFC), which provides a deferral of taxes until sale (realization). Long-term capital gains rates apply if held 12 months or longer. (i.e., VXX). However, prepaid forward contracts are not securities. Therefore, they are not subject to WS loss adjustments and Section 475 if elected. Many 1099-Bs treat ETN PFC as securities subject to WS. Consider departing from the 1099-B with footnote disclosure. Some ETNs, like UGAZ, are debt instruments taxed as securities, which means they are subject to WS losses and Section 475 if chosen. (Check the tax section of the ETN prospectus and see Other Financial Products.)

Cryptocurrencies
Selling, exchanging, or using cryptocurrency triggers capital gains and losses for traders. The IRS treats cryptocurrencies as intangible property; not a security or a commodity.

The realization method applies to short-term vs. long-term capital gains and losses. If you invested in cryptocurrencies and sold, exchanged, or spent some during the year, you have to report a capital gain or loss on each transaction. Include cryptocurrency-to-currency sales, crypto-to-alt-crypto trades, and purchases of goods or services using crypto.

U.S. cryptocurrency exchanges issue a Form 1099-K to accounts with transactions over a certain threshold. The problem for the IRS is that many cryptocurrency transactions on exchanges around the world are not evident for tax reporting. Cryptocurrency investors should download all crypto transactions into a crypto accounting program that is IRS-compliant.

Wash sales do not apply to intangible property. Use the first-in-first-out (FIFO) accounting method. Intangible property should use the specific identification method, but that requires broker confirmation of each trade, which is not possible.

TCJA restricted Section 1031 like-kind exchanges to real property, starting in 2018. That rules out using like-kind exchange on crypto-to-crypto trades (i.e., Bitcoin for Ethereum). It’s questionable whether crypto traders could have used Section 1031 before 2018 to defer capital gains taxes. The IRS promised the public more advice on crypto, and it recently mailed tax “education” notices to crypto traders. I hope the IRS addresses Section 1031, hard forks or chain splits, and several other open questions. (See Watch Out Cryptocurrency Owners; The IRS Is On The Hunt.)

Swap contracts
The Dodd-Frank financial regulation law promised to clear private swap transactions on exchanges to protect the markets from another swap-induced financial meltdown. Remember those credit default swaps with insufficient margin? When Congress enacted Dodd-Frank, traders hoped that clearing on futures exchanges would allow Section 1256 tax treatment. They were wrong: Congress and the IRS immediately communicated that Section 1256 would not apply to swap transactions, and they confirmed ordinary gain or loss treatment.

Roger D. Lorence JD contributed to this blog post.

Join my upcoming Webinar on October 23, 2019, or watch the recording after to learn more about this content: Trader Tax Strategies 2019 Year-End Update

For more information on wash sales and Section 475, see How Traders Get Enormous Tax Deductions, And Investors Do Not.

For more in-depth information, see Green’s 2019 Trader Tax Guide


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