Category: Tax Changes & Planning

Tax Planning For S-Corps

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

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

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

S-CORP OFFICER COMPENSATION

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

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

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

S-CORP HEALTH INSURANCE

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

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

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

S-CORP RETIREMENT PLAN CONTRIBUTION

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

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

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

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

SALT CAP

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

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

HAVE YOUR NEW ENTITY READY ON JAN. 1, 2024

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

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

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

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

 


Tax Planning For Traders

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

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

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

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

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

EXCESS BUSINESS LOSSES AND NET OPERATING LOSSES

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

DEFER INCOME AND ACCELERATE TAX DEDUCTIONS

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

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

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

ACCELERATE INCOME AND DEFER CERTAIN DEDUCTIONS

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

ROTH IRA CONVERSION

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

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

Generally, there’s a 10% excise tax on early withdrawals from retirement plans before age 59½. With a Roth IRA conversion, you can avoid excise tax by paying conversion taxes outside the Roth plan. TCJA repealed the recharacterization option, so you can no longer reverse the conversion if the plan assets decline. Roth IRA conversions have no income limit, unlike regular Roth IRA contributions.

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

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

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

NET INVESTMENT INCOME TAX

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

BUSINESS EXPENSES AND ITEMIZED DEDUCTION VS. STANDARD DEDUCTION

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

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

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

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

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

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

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

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

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

ESTIMATED INCOME TAXES

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

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

See Interest rates increase for the fourth quarter 2023. 

ADJUST WITHHOLDING ON YEAR-END PAYCHECKS

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

AVOID YEAR-END WASH SALE LOSS ADJUSTMENTS

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

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

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

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

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

TRADER TAX STATUS AND SECTION 475

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

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

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

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

20% DEDUCTION ON QUALIFIED BUSINESS INCOME

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

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

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

SUSPENDING TTS AND SECTION 475

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

TAX-LOSS HARVESTING

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

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

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

TAX EFFICIENT SALES

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

STRADDLES AND THE CONSTRUCTIVE SALE RULES

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

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

CHARITABLE CONTRIBUTIONS

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

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

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

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

TAX RELIEF: PRESIDENTIALLY DECLARED DISASTER AREAS

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


Highlights From Green’s 2023 Trader Tax Guide

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

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

BUSINESS TRADERS FARE BETTER

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

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

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

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

CAN TRADERS DEDUCT TRADING LOSSES?

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

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

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

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

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

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

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

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

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

WASH-SALE LOSSES

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

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

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

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

EXCESS BUSINESS LOSS LIMITATION

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

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

See more about EBL and its thresholds in Chapter 2.

TAX TREATMENT ON FINANCIAL PRODUCTS

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

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

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

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

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

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

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

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

ENTITIES FOR TRADERS

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

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

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

RETIREMENT PLANS FOR TRADERS

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

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

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

DEDUCTION ON QUALIFIED BUSINESS INCOME

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

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

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

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

For more information, see Chapter 7 and Chapter 17.

SALT CAP WORKAROUND

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

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

DESK REFERENCE

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

Table of Contents

Highlights. 

Chapter 1  Trader Tax Status.

Chapter 2  Section 475 MTM Accounting. 

Chapter 3   Tax Treatment of Financial Products. 

Chapter 4  Accounting for Trading Gains & Losses. 

Chapter 5   Trading Business Expenses.

Chapter 6  Trader Tax Return Reporting Strategies.

Chapter 7  Entity Solutions. 

Chapter 8  Retirement Plans.

Chapter 9  Tax Planning.

Chapter 10  Dealing with the IRS and States.

Chapter 11  Traders in Tax Court.

Chapter 12  Proprietary Trading. 

Chapter 13   Investment Management.

Chapter 14   International Tax. 

Chapter 15  ACA Net Investment Income Tax. 

Chapter 16   Short Selling. 

Chapter 17  Tax Cuts and Jobs Act.

Chapter 18  CARES Act.

 


2022 Year-End Tax Planning For Traders

October 25, 2022 | By: Robert A. Green, CPA | Read it on

Join our Webinars on Nov. 8 and 15, 2022, on Year-End Tax Planning For Traders, or watch the recordings afterward. 

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

It’s helpful to consider IRS inflation adjustments in income and capital gains tax brackets, various income thresholds and caps, retirement plan contribution limits, standard deductions, and more. See IRS provides tax inflation adjustments for tax year 2022, and IRS provides tax inflation adjustments for tax year 2023. The IRS increase for 2023 is about 7%.

Excess business losses and net operating losses
Some traders eligible for trader tax status (TTS) and who filed a timely Section 475 election incurred ordinary business losses for 2022. Before the Tax Cuts and Jobs Act (TCJA) started in 2018, a TTS/475 trader could carry back a net operating loss (NOL) for two years, generating a tax refund. TCJA introduced an “excess business loss” (EBL) limitation, with the excess being an NOL carryforward. TCJA repealed NOL carrybacks (except for farmers) and limited NOL carryforwards to 80% of the subsequent year’s taxable income. CARES suspended TCJA’s EBL and NOL changes for 2018, 2019, and 2020 and allowed five-year NOL carrybacks (i.e., a 2020 NOL carryback to 2015). TCJA’s EBL and NOL carryforward rules apply for tax years 2021 through 2028. (See How Traders Elect 475 To Maximize Their Tax Savings.)

Defer income and accelerate tax deductions
Consider deferring income and accelerating tax deductions if you don’t expect your taxable income to decline in 2023.

Traders eligible for trader tax status in 2022 should consider accelerating trading business expenses, such as purchasing business equipment with first-year expensing using Section 179 or bonus depreciation.

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

Accelerate income and defer certain deductions
A TTS trader with substantial Section 475 ordinary losses should consider accelerating income to soak up the EBL. Try to advance enough income to use the standard deduction and take advantage of lower tax brackets. Stay below the threshold for unlocking various AGI-dependent deductions and credits. A higher income can lead to an IRMA adjustment raising Medicare premiums.

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

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

Generally, there’s a 10% excise tax on “early withdrawals” from retirement plans before age 59½. With a Roth IRA conversion, you can avoid excise tax by paying conversion taxes outside the Roth plan. TCJA repealed the recharacterization option, so you can no longer reverse the conversion if the plan assets decline. Roth IRA conversions have no income limit, unlike regular Roth IRA contributions.

As an illustration, a taxpayer filing single has a $405,000 TTS/475 ordinary business loss. However, the excess business loss limitation for a single filing status in 2022 is $270,000 ($540,000 for married), so $135,000 is an NOL carryover. The taxpayer should consider a Roth conversion to soak up most of the $270,000 allowed business loss and leave enough income to use the standard deduction and lower tax brackets.

Zero tax rate on long-term capital gains in the lowest tax bracket
If you have a low income, consider realizing long-term capital gains by selling open positions held for more than 12 months. The 2022 long-term capital gains rates are 0% for taxable income in the 10% and 12% ordinary tax brackets. The 15% capital gains rate applies to the regular middle brackets, and the top capital gains rate of 20% applies to the top 37% ordinary income bracket. See capital gains tax brackets at https://taxfoundation.org/2022-tax-brackets/. Remember, if you go $1 over the zero-rate bracket, all the long-term gains are subject to the 15% capital gains rate; it doesn’t work like progressive marginal ordinary tax brackets.

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

Business expenses and itemized deduction vs. standard deduction

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

TCJA expanded first-year 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. Traders with TTS in 2022 may consider going on a shopping spree before January 1. There is no sense in deferring TTS expenses because you cannot be sure you will qualify for TTS in 2023.

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 year-end. TCJA suspended unreimbursed employee business expenses. TTS S-Corps should use an accountable plan to reimburse employee business expenses since the trader/owner is its employee.

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

SALT cap: TCJA capped state and local income, sales, and property taxes (SALT) at $10,000 per year ($5,000 for married filing separately) and did not index it for inflation. About 25 states enacted SALT cap workaround laws. Search “(Your state) SALT cap workaround” to learn the details for your state. Most states follow a blueprint approved by the IRS.

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

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

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

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

Estimated income taxes
Those who have reached the SALT cap don’t need to prepay 2022 state-estimated income taxes by December 31, 2022 (a strategy before TCJA). Taxpayers should pay federal and state estimated taxes owed by January 17, 2023, and the balance by April 18, 2023.

Many traders skip making quarterly estimated tax payments during the year, figuring they might incur trading losses later in the year. They can catch up with the Q4 estimate due by January 17, 2023, but might still owe an underpayment penalty for Q1 through Q3 quarters. Some rely on the safe harbor exception to cover their prior year’s taxes. (See Traders Should Focus On Q4 Estimated Taxes Due January 18.)

See IRS announces interest rate increases for the fourth quarter of 2022; 6% rate applies to most taxpayers starting October 1.

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

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

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

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

Starting a new entity effective January 1, 2023, can break the chain on individual account WS at year-end 2022, provided you don’t purposely avoid WS with the related party entity. The new entity can also elect Section 475 MTM.

WS losses might be preferable to capital loss carryovers at year-end 2022 for TTS traders. A Section 475 election in 2023 converts year-end 2022 WS losses on TTS positions (not investment positions) into ordinary losses in 2023. That’s better than a capital loss carryover into 2023, which might give you pause when making a 2023 Section 475 election. You want a clean slate with no remaining capital losses before electing Section 475 ordinary income and loss. (Learn how to read a broker 1099-B in connection with wash sale loss adjustments at How To Avoid Phantom Income From Wash Sale Loss Adjustments.)

Trader tax status and section 475
Traders who qualified for TTS in 2022 may accelerate trading expenses into that qualification period as sole proprietors or entities. Those who don’t qualify until 2023 should try to defer trading expenses until then. Traders may also capitalize and amortize (expense) Section 195 startup costs and Section 248 organization costs in the new TTS business, going back six months before commencement. TTS is a prerequisite for electing and using Section 475 MTM.

TTS traders choose Section 475 on securities to be exempt from wash-sale loss rules and the $3,000 capital loss limitation and be eligible for the 20% QBI deduction. To make a 2022 Section 475 election, individual taxpayers had to file an election statement with the IRS by April 18, 2022 (March 15, 2022, for existing S-Corps and partnerships). If they filed that election statement on time, they need to complete the election process by submitting a 2022 Form 3115 with their 2022 tax return. Those who missed the 2022 election deadline may want to consider the election for 2023. Capital loss carryovers are a concern — they can be used against capital gains but not Section 475 ordinary income. The 475 election remains in effect each year until it is revoked in the same manner as the election was made.

A Section 475 election made by April 18, 2023, takes effect on January 1, 2023. When converting from the realization (cash) method to the mark-to-market (MTM) method, a Section 481(a) adjustment needs to be made on January 1, 2023. The adjustment essentially reports in 2023 taxable income the unrealized capital gains and losses on open TTS securities positions held on December 31, 2022. The adjustment should not be made for year-end investment positions, and those who don’t qualify for TTS at year-end 2022 won’t have a Section 481(a) adjustment to report for the 2023 tax year. A “new taxpayer” entity can elect Section 475 within 75 days of inception — a good option for those who missed the individual sole proprietor deadline (April 18, 2022). Forming a new entity on November 1, 2022, or later is too late for establishing TTS for the 2022 year within the entity; we like to see all of Q4 for entity TTS eligibility at a minimum. Consider waiting until January 1, 2023, to start a new TTS entity and elect Section 475.

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

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

Taxpayers might be able to increase the QBI deduction with thoughtful year-end planning. Suppose taxable income falls within the phase-out range for a specified service activity or even above for a non-service business. You might need higher S-Corp wages (including officer compensation) to avoid a W-2 wage limitation on the QBI deduction. Deferring income can also help get under various QBI restrictions and thresholds. (Learn more about QBI, the thresholds, and income caps at How Traders Elect 475 To Maximize Their Tax Savings.)

Suspending TTS and Section 475
Tens of thousands of new TTS traders joined the profession during the Covid pandemic in 2020 and 2021, and many did well in those years. With the advent of a bear market correction in 2022, some “Covid traders” incurred substantial losses, and several stopped TTS trading. Perhaps, they are eligible for TTS and Section 475 for part of the year.

Assume a TTS/475 trader stopped trading on June 30, 2022. They must use Section 475 through June 30, 2022, but may not use it for the remainder of the year. TTS and 475 are “suspended” until and unless the trader is eligible again for TTS in a subsequent year. The trader can also revoke the 475 election for 2023 by April 18, 2023, in a mirror process to making a 475 election. Without 475 going into year-end, the trader should try to avoid wash sale loss adjustments at year-end. (See Will The IRS Deny Tax Benefits To Traders Due To Covid?)

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

S-Corps pay officer compensation in conjunction with employee benefit deductions through payroll tax compliance done before year-end 2022. Otherwise, traders miss the boat. TTS is a must since an S-Corp investment company cannot have tax-deductible wages, health insurance, and retirement plan contributions. A trading S-Corp is not required to have “reasonable compensation,” so a TTS trader may determine officer compensation based on how much to reimburse for health insurance and how much they want to contribute to a retirement plan. Remember, sole proprietor and partnership TTS traders cannot pay salaries to 2% or more owners; hence the S-Corp is needed.

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

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

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

A taxpayer can deduct a contribution to a health savings account (HSA) without TTS or earned income. HSA contribution limits for 2022 are $3,650 for individuals and $7,300 family, with an additional $1,000 for those aged 55 or older. HSAs must be funded and utilized before year-end.

S-Corp retirement plan contribution
TTS S-Corps can unlock a retirement plan deduction by paying sufficient officer compensation in December 2022 when results for the year are evident. Net income after deducting wages and retirement contributions should be positive.

If desired, you must establish a Solo 401(k) retirement plan for a TTS S-Corp with a financial intermediary before the year-end. Plan to pay the 100%-deductible “elective deferral” amount up to a maximum of $20,500 (or $27,000 if age 50 or older with the $6,500 catch-up provision) with the December 2022 payroll. That elective deferral is due by the end of January 2023. You can fund the 25% profit-sharing plan (PSP) portion of the S-Corp Solo 401(k) up to a maximum of $40,500 by the 2022 S-Corp tax return, including an extension, which means September 15, 2023. The maximum PSP contribution requires wages of $162,000 ($40,500 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.

The IRS raised the 401(k) elective deferral for 2023 to $22,500, up by $2,000 (9.8%) from 2022. The catch-up contribution limit is increased to $7,500, up by $1,000 from 2022. See IRS site 401(k) limit increases to $22,500 for 2023, IRA limit rises to $6,500.

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

Traditional retirement plans have required minimum distributions (RMD) by age 72, whereas Roth plans don’t have RMD. CARES waived RMD for 2020, but RMD applies for 2021, 2022, and subsequent years.

Have your new entity ready on January 1, 2023
If you missed employee benefits (health insurance and retirement contributions) in 2022, consider an LLC with an S-Corp election for the tax year 2023. Or maybe you want a spousal-member LLC taxed as a partnership for 2023 to maximize the SALT cap workaround and segregate trading from investing.

If you want the new entity to be ready to trade on the first trading day of January 2023, consider the following plan. Form a single-member LLC in December 2022, obtain the employee identification number (EIN) online, and open the LLC brokerage account before year-end to be ready to trade as of January 1, 2023. The single-member LLC is a “disregarded entity” for the tax year 2022, which avoids an entity tax return filing for the 2022 initial short year. You can add your spouse as an LLC member on January 1, 2023, creating a partnership tax return for 2023. 

If you want health insurance and retirement plan deductions for 2023, then your single-member or spousal-member LLC should submit a 2023 S-Corp election within 75 days of January 1, 2023.

The partnership or S-Corp is a “new taxpayer” to make an internal resolution to elect Section 475 MTM on securities only for 2023 within 75 days of January 1, 2023. Otherwise, existing partnerships or S-Corps must file an external 475 election statement with the IRS by March 15, 2023.

Tax-loss harvesting
If you have an investment or trading portfolio, you can reduce capital gains taxes via “tax-loss harvesting” before the year-end. If you realized significant capital gains year-to-date in 2022 and have open positions with substantial unrealized capital losses, consider selling some of those losing positions to reduce 2022 taxes on capital gains.

Be sure to wait 30 days to repurchase those securities to avoid wash sale loss adjustments, which would postpone the 2022 year-end tax loss to 2023, thereby defeating the concept of tax loss selling.

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

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

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

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

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

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

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

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

Tax relief: presidentially declared disaster areas
There were many disasters in 2022, including hurricanes and wildfires. Check the irs.gov site for Tax Relief in Disaster Situations.

Star Johnson, CPA, contributed to this blog post.


How to Deduct State and Local Taxes Above SALT Cap

August 3, 2021 | By: Robert A. Green, CPA | Read it on

Updates: As states progress on SALT cap workaround legislation, I update that news at the bottom of my prior post: Unlock State & Local Tax Deductions With A SALT Cap Workaround.

Are you disenfranchised from state and local tax deductions because you exceed the SALT cap of $10,000 per year? 

Organizing an LLC for your business can convert non-deductible SALT into a business expense. Seventeen states have enacted SALT cap workaround laws, and several others are working towards enactment. IRS Notice 2020-75, issued on Nov. 9, 2020, gave the green light to these state laws. Most states drafted their rules to comply with this notice. 

These state laws seem to include a trading business eligible for trader tax status (TTS) but not investment companies. (The reason: TTS entities have business expense treatment, whereas investment companies have suspended investment expenses.)

The states that have enacted SALT cap workaround laws with the effective date:

There is pending legislation in Illinois, Massachusetts, Michigan, North Carolina, Oregon, and Pennsylvania. (Most have passed, see updates).

These SALT cap workaround laws don’t significantly impact state revenues and incentivize entrepreneurs to remain in their state. Even if Congress repeals or revises the SALT limitation, the SALT cap workaround is the better option since you can deduct business expenses from gross income versus itemized deductions subject to an AMT limitation.

California’s new law automatically repeals its SALT cap workaround if Congress repeals the SALT cap limitation. For details on California and several other state laws, see ongoing updates to my June 22, 2021 blog post, Unlock State & Local Tax Deductions With A SALT Cap Workaround. Also, the podcast SALT workaround elective pass-through entity tax (Spidell’s California Minute, July 18, 2021) is an excellent listen for California residents.

TTS traders have other compelling reasons to consider an LLC partnership or S-Corp. 

  • A new LLC taxed as a partnership or S-Corp (pass-through entity PTE) can elect Section 475 MTM within 75 days of inception. That comes in handy since the individual sole proprietor deadline for a 475 election has passed. Section 475 provides tax-loss insurance through its exemption from wash sales and the capital loss limitation. Also, it offers a chance to get a 20% qualified business income (QBI) deduction on TTS/475 net income. 
  • An LLC taxed as an S-Corp unlocks health insurance and retirement plan deductions for TTS traders.

Now more than ever before may be the time to form your TTS entity, but you need to act quickly. Trading in an entity brokerage account for at least all Q4 2021 will help you qualify for TTS. The entity can only pay SALT business expenses on the entity income.

Many states require an election, some by partner, and SALT PTE tax payments have due dates. Dig into the details of your state, and we can help. Don’t miss the boat!

Darren Neuschwander, CPA, contributed to this blog post.


Unlock State & Local Tax Deductions With A SALT Cap Workaround

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

Updates: As states progress on SALT cap workaround legislation, I will update that news at the bottom of this post. Also, see my August 3, 2021 blog post, How to Deduct State and Local Taxes Above SALT Cap.

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

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

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

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

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

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

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

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

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

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

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

Updated news by state below

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

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

New Jersey enacts SALT deduction cap workaround (Grant Thorton Feb. 14, 2020)
NJ Bill Would Amend SALT Cap Workaround (Law360 Dec 13, 2021).
“A.B. 6185 would make changes to the credit structure and calculation method of the elective pass-through entity tax. According to the bill, the new way of calculation would allow for a larger credit to be obtained by a payer of the optional tax. The bill would also realign the tax’s brackets to align with the new state tax brackets, the bill said.”

California Lawmakers, Governor Float SALT Cap Workaround Plans (Bloomberg Tax Jan. 14, 2021)
“A new California Senate bill (SB 104) would give pass-throughs—partnerships, limited liability companies, and S corporations—the option to pay an entity-level income tax that would be fully deductible. The bill doesn’t specify a tax rate yet. Individuals who are members of those businesses would exclude the amount the entity pays from their gross income.” (Governor) Newsom’s proposal is narrower, applying only to S corporations. It would give those businesses the option to pay a 13.3% income tax rather than the 1.5% that California currently imposes on S corporations. Shareholders would get a tax credit equal to 13.3% of their passed-through income. Under current California law, an S corporation’s income is also taxable at the shareholder level.”
Calif. Gov. Updates Budget With Tax Rebates, SALT Workaround (Law360 May 14, 2021)
California budget deal reached: More stimulus payments and tax relief (Spidell News June 28, 2021)
“The Governor and legislative leaders announced that they have reached a budget deal. Major tax-related items contained in the deal include an elective passthrough entity tax, which provides a work-around to the $10,000 SALT deduction limitation for owners of passthrough entities…These provisions are contained in draft legislation that has not yet been enacted, although it is anticipated that these bills will be passed within the next week or two.” https://leginfo.legislature.ca.gov/
SALT Cap Workaround, Tax Credit Boosts Go To California Governor (Bloomberg Tax July 1, 2021)
“A California workaround to the $10,000 federal cap on state and local tax deductions, expanded tax credits, and new grants for businesses are included in bills lawmakers sent Thursday to Gov. Gavin Newsom (D). Tax policy changes in a bill lawmakers passed Thursday (A.B. 150) include a workaround for the $10,000 cap on state and local tax deductions for S corporations and their shareholders. The corporations could pay 9.3% income tax rather than the 1.5% rate California currently imposes. Shareholders would get a tax credit equal to 9.3% of their passed-through income. The workaround would be in effect for taxable years 2021 through 2025 and taxpayers would have to use the option on original, timely filed tax returns.
Calif. Joins States With SALT Cap Workaround (Law360 July 16, 2021)
“Gov. Gavin Newsom, a Democrat, signed A.B. 150… he reiterated his position that the cap on the SALT deduction should be lifted but said California would provide “a partial fix” for S corporations and other pass-throughs. California’s SALT workaround for pass-through entities will be an elective tax that the entity pays on behalf of partners. The partners can then receive a credit. The tax rate will be 9.3% and will fall on the distributive shares of income of the partners. Individual partners can choose not to consent, but the entity can still elect to pay the tax. Those partners who do consent will get a nonrefundable credit that equals the amount of tax paid by the entity on the partners’ behalf. The pass-through workaround will begin for tax year 2021 and sunset after tax year 2025, according to the analysis.”
SALT workaround elective passthrough entity tax (Spidell’s California Minute July 18, 2021)
Passthrough entity tax FAQs released by FTB (Spidell Sept. 30, 2021)
“The FTB anticipates releasing the new passthrough entity tax voucher before December 2021. That voucher will provide instructions on how to make the elective tax payment going forward. Note that for federal purposes, the entities will only benefit from the reduction of net income on the 2021 K-1s if the payment is made before the end of the entity’s 2021 taxable year.”
Help with pass-through entity elective tax FAQs (FTB)
“A qualified entity must make the election on its original, timely filed return.”

New York Includes SALT Cap Workaround in Budget Deal (Bloomberg April 6, 2021)
“The deal between New York Gov. Andrew Cuomo (D) and Democratic legislative leaders, announced Tuesday, would allow pass-through businesses to pay taxes at the entity level. The entity-level tax would be offset by a corresponding individual income tax credit.”
New York Governor Signs Bill That Could Provide Pass-Through Entities a SALT Deduction Cap Workaround (NYSSCPA April 10, 2021)
New York State Budget Provides A Work Around To The Federal SALT Cap For Certain Business Entities (Forbes May 27, 2021)
SALT Cap Workaround Rules Due Soon From New York Tax Department (Bloomberg Tax Aug. 19, 2021)
“New York business owners hankering to seize on a fresh tax break may get guidance from the state’s tax department as early as next week, according to a source familiar with the matter.”
NYS Tax Department: New guidance and election application for optional pass-through entity tax (NYS Tax Dept, Aug. 25, 2021) The New York State Tax Department has issued a technical memorandum and webpage to provide information on the new optional PTET.
New York State’s New Pass-Through Entity Tax – The CPA Journal (CPA Journal Aug. 2021)
“Election. To file and pay PTE tax, an eligible partnership or S corporation must make an irrevocable election by the first estimated payment due date, which is March 15 of the calendar year prior to the year in which the PTE tax return is required. The election is made annually and will be effective for the current taxable year. For the 2021 tax year only, an election must be made by October 15, 2021.
New York Pass Through Entity Tax Update & How to Actually Make the Election (linkedin.com) (Sept. 21, 2021)
New York’s Passthrough Entity Tax (CliftonLarsonAllen LLP Sept. 30, 2021). 
“Only an authorized person, as defined, may make this election on behalf of an eligible S corporation or partnership. The PTET election application can be filed electronically by creating a business online services account with the New York State Department of Taxation and Finance.

Alabama Lawmakers Advance Changes to SALT Cap Workaround (Tax Notes April 15, 2021)
Ala. Floats Rule For SALT Cap Workaround (Law360 Sept. 1, 2021)
“The rule, published in Tuesday’s state register, would provide that required annual payments are the lesser of 100% of the tax shown for the taxable year or 100% of the tax shown for the preceding year. The proposed rule also provides that while an entity is transitioning to being taxed at the entity level, required estimated quarterly payments will be 25% of the required annual payment.”

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

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

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

SC Offers SALT Cap Workaround Through Entity-Level Tax (Law360 May 19, 2021)
“Republican Gov. Henry McMaster signed S.B. 627 on Monday, allowing partnerships and S corporations to make an annual election to pay a 3% tax at the entity level while offering a corresponding income exclusion for owners and partners. The bill will take effect starting in tax year 2021.”
SC Issues Guidance On SALT Cap Workaround (Law360 Dec 3, 2021).
“The owners of pass-through entities that elect to pay tax at the entity level on income apportioned to South Carolina will have that income excluded from their state taxable income, the state Department of Revenue said in a ruling Friday.”

Illinois Assembly Approves SALT Workarounds for Partnerships (Bloomberg Tax May 31, 2021)
Illinois Enacts SALT Cap Workaround for Pass-Through Businesses  (Bloomberg Tax Aug. 27, 2021)
Gov. “Pritzker signed S.B. 2531, which allows partnerships and S corporations to pay their income tax at the entity-level rate of 4.95% and then claim a credit on their state return.” The annual election is irrevocable and the tax benefit is available for tax years ending on or after Dec. 31, 2021, and before Jan. 1, 2026.
Ill. Offers Estimated Payment Penalty Relief For Entity-Level Tax (Law30 Sept. 9, 2021)
“Illinois will waive penalties for late estimated payments for the state’s new entity-level tax that acts as a workaround to the federal cap on state and local tax deductions, the state Department of Revenue announced Thursday.”

SALT Workaround for Pass-Throughs Advances to Michigan Governor (Bloomberg Tax June 23, 2021)
“The SALT cap workaround bill (H.B. 4288) could provide roughly $190 million in federal tax relief for Michigan businesses without costing the state a dime, according to a legislative fiscal statement. The measure would let pass-through businesses pay state and local taxes at the entity level starting in tax year 2021, allowing the full deduction of these taxes on federal returns instead of limiting the deduction amount the entity owners can currently claim on their flow-through income.”
Mich. Gov. Vetoes SALT Deduction Cap Workaround Bill (Law360, July 14, 2021).
Michigan’s governor vetoed a bill seeking to create an entity-level tax for pass-through businesses to sidestep the federal cap on state and local tax deductions, saying the bill’s $5 million cost to implement should be part of broader budget negotiations.
Mich. Lawmakers OK Budget Funding SALT Cap Workaround (Law360 Sept. 23, 2021)
“Michigan lawmakers approved a nearly $70 billion budget that includes funding necessary to implement a state and local tax deduction cap workaround for pass-throughs that the governor previously vetoed due to reservations about the program’s cost.”
Michigan Budget Funds SALT Cap Workaround (Law360 Sept. 29, 2021)
“Michigan Gov. Gretchen Whitmer signed the state’s budget Wednesday, including a provision with funding necessary to implement a state and local tax deduction cap workaround for pass-throughs that she previously vetoed due to reservations about the program’s cost.”
Mich. House Fast-Tracks Refiled SALT Cap Workaround Bill (Law360 Oct. 7, 2021)
“Michigan lawmakers moved quickly Thursday to allow a vote on a refiled entity-level tax bill to sidestep the $10,000 federal cap on state and local tax deductions, following the governor’s pledge to support the program after its funding was secured.”
Michigan House Passes Refiled SALT Cap Workaround Bill (Law360 Oct. 14, 2021).
“Michigan’s House of Representatives passed legislation Thursday that would offer an entity-level tax permitting pass-through businesses to sidestep the $10,000 federal cap on state and local tax deductions — a program for which the state’s budget specifically earmarked funding.”
Michigan Lawmakers OK SALT Cap Workaround (Law360Dec 15, 2021).
“Pass-through businesses in Michigan could sidestep the federal cap on state and local tax deductions under a bill headed to the governor’s desk.”

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

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

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

Rhode Island Budgets For Salt Workaround (Aug. 2019)

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

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

North Carolina Republicans Introduce SALT Cap Workaround (Tax Notes April 8, 2021)
NC House OKs Budget With Tax Cuts, SALT Cap Workaround (Law 360 Aug. 13, 2021)
“Democratic Gov. Roy Cooper opposes H.B. 334.”

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

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

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

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

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

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

Some states now offer certain business owners a workaround for cap on state and local tax deduction (CNBC July 22, 2021)

Sens. Endorse Easing SALT Cap, Killing ARPA Tax Cut Limits (Law360 Aug. 11, 2021)
“Under the budget resolution Democrats advanced early Wednesday, a priority for the Senate Finance Committee would be “SALT cap relief.” No definition of relief or other detail is provided… Sen. Chuck Grassley, R-Iowa, offered an amendment to the budget resolution to leave the SALT cap untouched, calling the SALT deduction a provision “that mainly benefits the wealthy.” However, the amendment failed 48-51.”

California Drivers And Ohio Musicians: SALT In Review (Law360 Sept. 3, 2021)
“The good folks at the Institute on Taxation and Economic Policy released a report on potential changes to the SALT deduction limits. ITEP looked at several scenarios:”

NJ Dem Reps Say No SALT Cap Repeal, No Reconciliation (Law360 Sept. 20, 2021)
“A group of New Jersey congressional Democrats said Monday that they will vote against a proposed $3.5 trillion reconciliation bill unless the federal deduction for state and local taxes is fully restored.”

Entity-Level Taxes Grow, But Future Uncertain, Tax Atty Says (Law360 Sept. 23, 2021)
“Although 20 states have adopted pass-through taxes at the entity level as a workaround to the $10,000 cap on the federal deduction for state and local taxes paid, these regimes face a highly uncertain future, a tax professional said Thursday. This month, Democrats on the House Ways and Means Committee released a preliminary $2.9 trillion package of tax increases that left out a repeal of the SALT cap. But House Ways and Means Chairman Richard E. Neal, D-Mass, and Ways and Means members Rep. Bill Pascrell, D-N.J. and Rep. Tom Suozzi, D-N.Y., said afterward that although the measure was left out, they were committed to enacting a law “that will include meaningful SALT relief.”

2nd Circ. Rejects States’ Challenge To Fed. SALT Cap (Law360 Oct. 5, 2021)
“The federal $10,000 deduction cap on state and local taxes is constitutional, the Second Circuit said Tuesday, finding a challenge to the limitation by Maryland, New York, New Jersey and Connecticut…”

SALT-Cap Relief Faces Rollback as Democrats Eye Less Spending (Bloomberg Tax Oct. 4, 2021)
“Democrats risk settling for a less generous expansion of the state and local tax deduction than previously hoped after President Joe Biden conceded that lawmakers will have to scale back his economic agenda to get it enacted.”

Ohio Bill Seeks Entity-Level Tax To Bypass SALT Cap (Law360 Oct. 6, 2021)
“Under the (proposed) bill, entities that elect to be taxed at the entity level would have to make separate, irrevocable elections each tax year, starting in the entity’s tax year that begins in 2022. The tax rate would be 5% for 2022 and would then be the rate on taxable business income, currently 3%, for later years.”

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

 

 

 

 

 

 

 

 

 

 

 

 

 


The American Rescue Plan Act of 2021 Impacts Traders

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

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

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

2021 Recovery Rebates to Individuals

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

Extension of Limitation on Excess Business Losses (EBL)

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

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

Suspension of Income Tax on Portion of Unemployment Compensation

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

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

Child Tax Credit

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

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

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

Student Loan Forgiveness

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

Links

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

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

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

 

How Traders Improve Tax Savings With Year-End Strategies

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

Tax Planning

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Darren Neuschwander, CPA contributed to this blog post.


Traders Should Focus On Q4 Estimated Taxes Due Jan. 15

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

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

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

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

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

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

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

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

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

Darren Neuschwander CPA contributed to this blog post.


How Covid-19 Tax Relief & Aid Legislation Impacts Traders (Updates)

May 31, 2020 | By: Robert A. Green, CPA | Read it on

Tax tips for the July 15 deadline, extensions, 475 elections, NOL carrybacks, CARES relief, and more.

Update June 29: “IRS today announced the tax filing and payment deadline of July 15 will not be postponed. Individual taxpayers unable to meet the July 15 due date can request an automatic extension of time to file until Oct. 15 – it is not an extension to pay any taxes due. For people facing hardships, including those affected by COVID-19, who cannot pay in full, the IRS has several options available to help.” (See Taxpayers should file by July 15 tax deadline; automatic extension to Oct. 15 available.)

Watch our Webinar or recording Last-Minute Tax Tips & Extensions For Traders.

Original post

Congress postponed the tax filing and payment deadline from April 15 to July 15, 2020, for 2019 individual tax returns, extensions, and 2020 elections (i.e., Section 475). That’s good news for sole proprietor traders.

The July 15 deadline also applies to calendar-year 2019 C-Corps, U.S. residents abroad, estates, trusts, gift tax returns, information returns, IRA, and HSA contributions originally due April 1, or later.

Partnerships and S-Corps
Calendar-year 2019 partnership and S-Corp tax returns and 2020 Section 475 elections for partnerships and S-Corps were due March 16, 2020. These pass-through tax returns and entity 475 elections are not eligible for the July 15 postponement deadline because the March 16 deadline was before April 1. IRS virus relief guidance mentions pass-through entities, but that’s for a fiscal-year partnership or S-Corp tax return due on or after April 1, 2020.

Traders have calendar-year partnerships and S-Corps, so their entities are not eligible for the July 15 postponement relief. Some asked our firm if their existing partnership or S-Corp could take advantage of the postponed deadline for making a 2020 Section 475 MTM election. The answer is no.

Extensions for individual taxpayers
If you need more time to file your 2019 individual income tax return, file an automatic extension (Form 4868) for three additional months until October 15, 2020.

If you cannot pay the taxes you owe for 2019, then it’s essential to file the one-page extension to avoid IRS late-filing penalties of 5% per month for up to five months. The IRS charges this penalty based on the tax balance due. On Form 4868, enter your estimate of total tax liability for 2019, total 2019 payments, including overpayment credits, balance due, and the amount you’re paying. “If your return is more than 60 days late, the minimum penalty is $330 (adjusted for inflation) or the balance of the tax due on your return, whichever is smaller.” Even if you cannot pay any amount due, filing the extension on time avoids the late-filing penalty.

The IRS also charges late-payment penalties if the taxpayer does not pay at least 90% of their 2019 tax liability by the postponed deadline of July 15, 2020. The late-payment penalty is 0.5% per month, for up to five months, for a maximum of 2.5%. It’s ten times less than the late-filing penalty. For example, if the taxpayer owes $50,000 by July 15 but doesn’t pay it until October 15, 2020, the total penalty is $750 (three months of 0.5% equals 1.5% times $50,000).

The IRS allows the taxpayer to request abatement of late-payment and late-filing penalties based on a “reasonable cause.” Contracting coronavirus in your family or being negatively impacted by the virus might constitute a reasonable cause. “Attach a statement to your return, fully explaining the reason. Don’t attach the statement to Form 4868.”

The IRS calculates penalties and interest based on the tax payment paid after July 15.

The current interest rate on late payments is 4.5%, and the IRS does not forgive interest charges.

2020 estimated taxes
Treasury also postponed Q1 and Q2 quarterly estimated tax payments for 2020 until July 15, 2020. The original due dates were April 15 for Q1 and June 15 for Q2. Third and fourth quarters keep their original due dates of September 15, 2020, and January 15, 2021, respectively.

Mark your payment memo “2020 Form 1040-ES,” so the IRS does not confuse it with 2019 tax payments. Consider overpaying the 2019 extension, planning for an overpayment credit to apply to 2020 estimated taxes.

States also postponed the deadline
All states with a personal income tax have extended their April 15 due dates. See AICPA state filing conformity chart that they update.

Check if your state is decoupling from CARES, such as for NOL carrybacks. That’s happened in prior stimulus legislation.

Consider a section 475 election by July 15
If you have 2020 YTD trading losses and are eligible for trader tax status (TTS) as a sole proprietor, consider a 475 election on securities and or commodities due by July 15, 2020, the postponed tax deadline. Many traders have massive trading losses in 2020, and they desperately need a 475 election for ordinary loss treatment to unlock NOL carryback refunds.

Section 475 ordinary losses offset all types of income, which navigates around the $3,000 capital loss limitation. Section 475 securities trades are also exempt from wash-sale loss adjustments, which can create phantom income and capital gains taxes. I call Section 475, “tax loss insurance.” I generally recommend 475 for securities only to retain lower 60/40 capital gains rates on commodities (Section 1256 contracts). Section 475 does not apply to segregated investment positions so that you can enjoy deferral and long-term capital gains treatment, too.

There’s also a 20% QBI deduction on 475 income, net of TTS expenses. QBI excludes capital gains and portfolio income. Trading is a “specified service activity,” so you must be under the taxable income threshold of $326,600/$163,300 (married/other taxpayers) for 2020 to be eligible for the QBI tax deduction on TTS/475 income.

Be careful to follow the election rules properly. Attach a 2020 Section 475 election statement to your 2019 individual income tax return or extension filed by July 15, 2020.

E-filing an extension is convenient, but taxpayers cannot attach an election statement to an e-filed extension. Print the extension, attach the election, and mail or fax them together to the IRS.

If you are ready to file your tax return by July 15, there might be a problem: Most tax preparation software programs for consumers don’t include 475 elections. Either mail the 2019 tax return with 2020 Section 475 election statement attached, or e-file the tax return and send the election to the IRS separately by July 15. (See an example election statement and information about Form 3115 in Green’s 2020 Trader Tax Guide, chapter 2.)

CARES allows five-year NOL carrybacks
Starting with the 2018 tax year, TCJA 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 for married and $250,000 for other taxpayers for 2018) were considered an NOL carryforward. TCJA deferred losses into the future.

CARES suspended TCJA’s EBL limitation for 2018, 2019, and 2020. It also allows five-year NOL carrybacks for 2018, 2019, and 2020 and/or 100% application of NOL carryforwards.

Business owners should consider amending 2018 and 2019 tax returns to remove EBL limitations and consider five-year NOL carryback refund claims. It’s too late to elect 475 ordinary loss treatment for 2018 and 2019; a 2019 Section 475 election was due April 15, 2019. 2020 NOL carrybacks must wait until 2021 unless Congress speeds up that process with more virus legislation.

Businesses have until June 30, 2020, to file a 2018 Form 1045 (quickie refund) for a 2018 NOL carryback. They should get moving on these NOL carrybacks ASAP. Otherwise, they need Form 1040-X, which allows the IRS more time to process the refund.

TTS traders with Section 475 ordinary losses and those without 475 but who have significant NOLs from expenses (i.e., borrow fees on short-selling) should consider NOL carrybacks. If Congress changes the rules again (see below), your refund claim should be respected by the IRS as you filed based on current law in effect at the time.

The House passed new virus legislation
The House recently passed new virus legislation, backtracking on CARES business loss relief. However, the Senate rejected taking up this new House legislation. The House law restricts taxpayers to carry back NOLs from 2019 and 2020 only to tax years beginning on or after January 1, 2018.

The House legislation retains EBL limitations for 2018, 2019, and 2020 and it lifts the SALT limitation for 2020 and 2021. Proponents of the House bill argued that CARES business loss relief mostly benefits the wealthy. Proponents of CARES claim small businesses, plenty of which are not wealthy, need NOL carryback refunds to replenish their capital to remain in business — a goal for virus relief. Opponents of the House bill say lifting SALT helps mostly upper-income taxpayers. Pundits expect Congress to enact more virus legislation, so stay tuned.

CARES tax relief and economic aid
CARES offered tax relief and economic aid to employees, independent contractors, sole proprietors, and other types of small businesses. However, traders don’t fit into usual categories, so there are issues in applying for some CARES tax relief and aid.

Traders generate “unearned income,” and the CARES Act focuses on “earned income” (jobs). Traders eligible for trader tax status (TTS) operating in an S-Corp might be able to receive state and federal unemployment benefits if they close their trading business due to the negative impact of the pandemic.

TTS traders don’t qualify for a loan under the SBA Paycheck Protection Program (PPP), or any other SBA loan because trading is considered a “speculative business,” which the SBA bars from its lending programs.

TTS traders might be eligible for NOL carrybacks, relaxed retirement plan distributions, and recovery rebates.

Taxpayers negatively impacted by Covid-19 can take a withdrawal from an IRA or qualified retirement plan of up to a maximum of $100,000 in 2020 and be exempt from the 10% excise tax on “early withdrawals.” The taxpayer has the option of returning (rolling over) the funds within three years or paying income taxes on the 2020 distribution over three years. CARES also suspended required minimum distributions for 2020.

Here’s an example
My client, Josh, was recently laid off due to Covid-19. He is collecting state unemployment insurance plus federal pandemic relief of $600 per week. Josh is eligible for the $100,000 early withdrawal from his employer 401(k), and he can pay taxes or roll it over during the following three years, depending on how things work out. Josh plans to use a 401(k) early withdrawal of $50,000 to finance a new TTS sole proprietorship.

Josh’s TTS Schedule C does not conflict with his unemployment insurance benefits because he is buying and selling capital assets and not collecting a salary. Josh plans to submit a Section 475 election on securities only for 2020, due by July 15, 2020. He wants tax loss insurance and to be eligible for a 20% QBI deduction.

Next year, after Josh’s unemployment insurance ends, he might form a TTS S-Corp to have a salary in December to unlock health-insurance and retirement-plan deductions. S-Corp salary would conflict with unemployment insurance. (It’s always best to check with your state.) The financial markets are highly volatile in 2020, so there’s an opportunity for traders, especially with zero commissions. Josh operates his trading business from home, where he is safer from the pandemic. Brokers have reported strong growth in new trading accounts.

See blog posts:
April 15 Tax Deadline Moved To July 15 (Live Updates)
Massive Market Losses? Elect 475 For Enormous Tax Savings
How Traders Should Mine the CARES Act For Tax Relief & Aid
Tax Extensions: 12 Tips To Save You Money
IRS Coronavirus Tax Relief

Darren Neuschwander CPA contributed to this blog post.