Category: Tax Changes & Planning

Highlights From Green’s 2019 Trader Tax Guide

January 15, 2019 | By: Robert A. Green, CPA | Read it on

Use Green’s 2019 Trader Tax Guide to receive every trader tax break you’re entitled to on your 2018 tax returns. Our 2019 guide covers the 2017 Tax Cuts and Jobs Act’s impact on investors, traders, and investment managers. Learn various smart moves to make in 2019.

Whether you prepare your 2018 tax returns as a trader or investor, this guide can help. Even though it may be too late for some tax breaks on 2018 tax returns, you can still use this guide to execute these tax strategies and elections for tax-year 2019.

Tax Cuts and Jobs Act

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

Like many small business owners, traders eligible for trader tax status (TTS) restructured their business for 2018 and 2019 to take advantage of TCJA. TCJA suspended investment fees and expenses, which makes TTS even more crucial. (TCJA continues to allow itemized deductions for investment-interest expenses and stock borrow fees.)

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

Tax forms changed with TCJA for 2018

TCJA required significant revisions to 2018 income tax forms. The redesigned two-page 2018 Form 1040 resembles a postcard because the IRS moved many sections to six new 2018 Schedules (Form 1040). It’s a block-building approach with the elimination of Form 1040-EZ and 1040-A.

See the new 2018 Schedule 1 (Form 1040) for reporting “Additional Income” including state tax refunds, Schedule C, D, E, Form 4797 (Section 475), and Other Income/Loss (Section 988 forex) on line 21. Schedule 1 (Form 1040) is also for reporting “Adjustments To Income,” previously called items of “adjusted gross income” (AGI).

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

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

TCJA introduced a new 20% deduction on qualified business income, but the IRS did not draft a tax form for it. A taxpayer must use a worksheet for the calculation and report a “qualified business income deduction” on the 2018 Form 1040, page 2, line 9.

Business traders fare better

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

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

Don’t confuse TTS with the related tax-treatment election of Section 475 MTM accounting.  The election converts new capital gains and losses into business ordinary gains and losses, avoiding the $3,000 capital loss limitation. Only qualified business traders may use Section 475 MTM; investors may not. Section 475 trades are also exempt from wash-sale loss adjustments.

A business trader can assess and claim TTS after year-end and even going back three open tax years. But business traders may only use Section 475 MTM if they filed an election on time, either by April 15 of the current year (i.e., April 17, 2018, for 2018) or within 75 days of inception of a new taxpayer (i.e., a new entity).

Can traders deduct trading losses?

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

Many traders are hoping to find a way to deduct their 2018 trading losses. Maybe they qualify for TTS, but that only gives them the right to deduct trading business expenses.

Securities, Section 1256 contracts, ETN prepaid forward contracts, and cryptocurrency trading receive capital gain/loss treatment by default. If a TTS trader did not file a Section 475 election on securities and/or commodities on time (i.e., by April 17, 2018), 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, which are not securities, or cryptocurrencies, which are intangible property.

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

Once taxpayers get in the capital loss carryover trap, a problem they often face is how to use up the carryover in the following year(s). If a taxpayer elects Section 475 by April 15, 2019, the 2019 business trading gains will be ordinary rather than capital. Remember, only capital gains can offset capital loss carryovers. Once a trader has a capital loss carryover hole, he or she needs a capital gains ladder to climb out of it and a Section 475 election to prevent digging an even bigger one. The IRS allows revocation of Section 475 elections if a Section 475 trader later decides he or she wants capital gain/loss treatment again. Even so, an entity is still better for electing and revoking Section 475 as needed.

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

Taxpayers with losses trading forex contracts in the off-exchange Interbank market may be in luck. By default, Section 988 for forex transactions receives ordinary gain or loss treatment, which means the capital loss limitation doesn’t apply. However, without TTS, the forex loss isn’t a business loss and therefore can’t be included in a net operating loss (NOL) calculation — potentially making it a wasted loss since it also can’t be added to the capital loss carryover. If taxpayer has another source of taxable income, the forex ordinary loss offsets it; the concern is when there is negative taxable income. Forex traders can file a contemporaneous “capital gains and losses” election in their books and records to opt out of Section 988, which is wise when capital loss carryovers exist. Contemporaneous means in advance — not after the fact using hindsight. In some cases, this election qualifies for Section 1256(g) lower 60/40 capital gains tax rates on major pairs, not minors.

A TTS trader using Section 475 on securities has ordinary loss treatment, which avoids wash-sale loss adjustments and the $3,000 capital loss limitation. Section 475 ordinary losses offset income of any kind, and a net operating loss carries forward to subsequent tax year(s). TCJA’s “excess business loss” (EBL) limitation of $500,000 married and $250,000 other taxpayers applies to Section 475 ordinary losses and trading expenses. Add an EBL to an NOL carryforward.

Tax treatment on financial products

There are complexities in sorting through different tax-treatment rules and tax rates. It’s often hard to tell what falls into each category.

Securities have realized gain and loss treatment and are subject to wash-sale rules and the $3,000 per year capital loss limitation on individual tax returns.

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

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

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

Physical precious metals are collectibles and, if these capital assets are held over one year, sales are subject to the taxpayer’s ordinary rate capped at 28% (the collectibles rate).

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

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

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

Don’t solely rely on broker 1099-Bs: There are opportunities to switch to lower 60/40 tax capital gains rates in Section 1256, use Section 475 ordinary loss treatment if elected on time, and report wash-sale losses differently. Vital 2019 tax elections need to be made on time.

Entities for traders

Entities can solidify TTS, unlock health insurance and retirement plan deductions, gain flexibility with a Section 475 election or revocation, and prevent wash-sale losses with individual and IRA accounts. An entity return consolidates trading activity on a pass-through tax return, making life easier for traders, accountants, and the IRS. Trading in an entity allows individually held investments to be separate from business trading. It operates as a separate taxpayer yet is inexpensive and straightforward to set up and manage.

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

Retirement plans for traders

Annual tax-deductible contributions up to $62,000 for 2019 to a TTS S-Corp Solo 401(k) retirement plan generally saves traders significantly more in income taxes than it costs in payroll taxes (FICA and Medicare). Trading gains aren’t earned income, so traders use an S-Corp to pay officer compensation.

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

20% deduction on qualified business income

In August 2018, the IRS issued proposed reliance regulations (Proposed §1.199A) for TCJA’s 20% deduction on qualified business income (QBI). (Postscript: On Jan. 18, 2019, the IRS issued final 199A regs.) The final regs confirm that TTS traders are a “specified service activity,” which means if their taxable income is above an income cap, they won’t get any QBI deduction. The 2018 taxable income (TI) cap is $415,000/$207,500 (married/other taxpayers). The phase-out range below the cap is $100,000/$50,000 (married/other taxpayers), in which the QBI deduction phases out for specified service activities. The W-2 wage and property basis limitations also apply within the phase-out range. TTS hedge funds and investment managers are specified service activities, too. The final 199A regs preamble confirm that QBI includes Section 475 ordinary income, whereas, TCJA expressly excluded capital gains and losses from it. (See our more recent blog posts, IRS Confirms Section 475 Is Eligible For QBI Tax Deduction and Uncertainty About Using QBI Tax Treatment For Traders.)

Affordable Care Act

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

ACA’s individual health insurance mandate and shared responsibility fee for non-compliance, exchange subsidies, and premium tax credits continue to apply for 2018 and 2019. However, TCJA reduced the shared responsibility fee to $0 starting in 2019.

Investment management carried interest

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

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

Investors also benefit from carried interest in investment partnerships. TCJA suspended “certain miscellaneous itemized deductions subject to the 2% floor,” which includes investment fees and expenses. Separately managed account investors are out of luck, but hedge fund investors can limit the negative impact by using carried-interest tax breaks. Carried interest reduces a hedge fund investor’s capital gains instead of having a suspended investment fee deduction.

Family office

Restructuring investment fees and expenses into a management company might achieve business expense treatment providing it’s a genuine family office with substantial staff rendering financial services to extended family members and outside clients.

The IRS might assert the family office is managing “one’s own investments,” not for outside clients, so the management company is also an investment company with non-deductible investment expenses.

Learn more about and purchase Green’s 2019 Trader Tax Guide and see the Table of Contents.

To Save Taxes, Traders Need To Deal With Unique Issues Before Year-End

October 31, 2018 | By: Robert A. Green, CPA | Read it on

While the 2017 Tax Cuts and Jobs Act did not change trader tax status, Section 475 MTM, wash-sale loss rules on securities, and more, there is still plenty to consider.

To Get The Most Out Of Tax Reform, Traders Need To Act Fast covered critical moves to make before the calendar year expires. But that’s just the tip of the hat. Read on for more action items to initiate sooner, rather than later.

Wash sales: Securities traders must comply with wash-sale loss rules, but the IRS makes it difficult by applying different standards for taxpayers vs. brokers on tax reports and Form 1099-Bs. Taxpayers must report wash sales on substantially identical positions across all accounts, whereas brokers report only identical positions per account. Active securities traders should use a trade accounting program or service to identify potential wash sale loss problems going into year-end. In taxable accounts, break the chain by selling the position before year-end and not repurchasing a substantially identical position 30 days before or after in any of your taxable or IRA accounts. Avoid wash sales between taxable and IRA accounts throughout the year, as that is otherwise a permanent wash sale loss. (Starting a new entity effective Jan. 1, 2019, can break the chain on individual account wash sales at year-end 2018 provided you don’t purposely avoid wash sales with the related party entity.) Read strategies to avoid wash sale losses. Wash sales only apply to securities; not Section 1256 contracts, cryptocurrencies as intangible property, and volatility ETNs structured as prepaid forward contracts.

Wash sale losses might be preferable to capital loss carryovers at year-end 2018 for TTS traders. A Section 475 election in 2019 converts year-end 2018 wash sale losses on TTS positions (not investment positions) into ordinary losses in 2019. That’s better than a capital loss carryover into 2019, which might then give you pause to making a Section 475 election. You want a clean slate with no remaining capital losses before electing Section 475 ordinary income and loss. (Learn more about wash sales and capital loss limitations in a video on our Website and consider our trade accounting service.)

Trader tax status: If you qualify for TTS (business expense treatment — no election needed) in 2018, accelerate trading expenses into that qualification period as a sole proprietor or entity. If you don’t qualify until 2019, try to defer trading expenses until then. You may also capitalize and amortize (expense) Section 195 startup costs and Section 248 organization costs in the new TTS business, going back six months before commencement. TTS is a prerequisite for electing and using Section 475 MTM. (Learn more about trader tax status in a video on our Website.)

Section 475 MTM: TTS traders choose Section 475 on securities for exemption from wash-sale rules and the $3,000 capital loss limitation — and to receive the new 20% QBI deduction. Existing individual taxpayers had to elect Section 475 by April 17, 2018, for 2018 (March 15 for existing S-Corps and partnerships). They need to complete the election process by filing a 2018 Form 3115 with their 2018 tax return. If you missed the 2018 election deadline, then consider the election for 2019. Capital loss carryovers are a concern.

Trading entities: A “new taxpayer” entity can elect Section 475 within 75 days of inception. But it’s getting late to form a new trading entity by the middle of November, and still qualify for TTS in that short period before year-end. Elect 475 once, and it applies in subsequent years in which you are eligible for TTS unless you revoke the election. (Learn more about Section 475 in a video on our Website.)

Net operating losses: Section 475 ordinary losses and TTS business expenses contribute to net operating loss (NOL) carryforwards, which are limited to 80% of taxable income in the subsequent year(s). TCJA repealed two-year NOL carrybacks, except for farmers. For some traders, this is the worst change in TCJA as traders have counted on quick NOL carryback refunds to replenish their trading accounts and remain in business. Get immediate use of NOLs with a Roth IRA conversion before year-end and other income acceleration strategies.

Excess business losses: TCJA introduced an “excess business loss” (EBL) limitation of $500,000/$250,000 (married/other taxpayers), per tax year. Aggregate EBL from all pass-through businesses: A profitable company can offset another business with losses to remain under the limit. EBL is an NOL carryforward. For example, if a single TTS/475 trader has an ordinary loss of $300,000, his EBL is $50,000, and it’s an NOL carryforward.

2018 S-Corp: TTS traders use an S-Corp trading company to arrange health insurance and retirement plan deductions. The S-Corp must execute officer compensation, in conjunction with these employee benefit deductions, through formal payroll tax compliance before year-end. Otherwise, you will miss the boat. TTS is an absolute must since an S-Corp investment company cannot have tax-deductible wages, health insurance, and retirement plan deductions. This S-Corp is not required to have “reasonable compensation” as other types of businesses are, so a TTS trader may determine officer compensation based on how much to reimburse for health insurance, and how much they want to contribute to a retirement plan. Some use a dual-entity solution: An LLC/partnership trading company, and a management company, organized as a C-Corp, or S-Corp. In that case, the management company executes year-end payroll and these employee benefits. (C-Corps can have other types of employee benefits, too.)

TTS traders organized as a sole proprietorship (an unincorporated business), cannot have health insurance and retirement plan deductions because they don’t have self-employment income (SEI) from trading income. A TTS Schedule C does not have a net income, and the IRS does not permit a TTS sole proprietor to pay officer compensation (wages) to themselves as owners. A TTS partnership faces obstacles in attempting to arrange health insurance and retirement plan deductions because the partnership passes through expenses for reducing SEI, whereas, an S-Corp does not pass through expenses or losses for SEI — that’s why the S-Corp works for traders.

An S-Corp formed later in the year can unlock a retirement plan deduction for an entire year by paying sufficient officer compensation in December when results for the year are evident. The S-Corp may only deduct health insurance for the months the entity was operational and qualified for TTS.

Another reason to create officer compensation is to increase the 20% QBI deduction if you are in the phase-out range subject to the 50% wage limitation. (See my other blog posts and Webinars on year-end planning for TTS S-Corps to execute health insurance, make retirement plan contributions, and generate a QBI deduction.)

2019 S-Corp: If you missed out on employee benefits in 2018, then consider an LLC/S-Corp for 2019. Starting 2019 with trading in the new S-Corp is beneficial. That breaks the chain on wash sales with your individual account at year-end 2018. If you start later, you will have tax compliance for your individual return and S-Corp return in dealing with broker 1099Bs and more.

If you wait to start your entity formation process on Jan. 1, 2019, you won’t be ready to trade in an entity account on Jan. 2, 2019. Instead, you can form a single-member LLC by mid-December 2018, obtain the employee identification number (EIN) at, and open the entity brokerage account before year-end. If desired, add your spouse as a member of the LLC on Jan. 1, 2019, which means the LLC will file a partnership return. If you want health insurance and retirement plan deductions, then your LLC should submit an S-Corp election for 2019 by March 15. The S-Corp should also consider making a Section 475 MTM election on securities only for 2019 by March 15. (Consider our entity formation service.)

Solo 401(k): A Solo 401(k) retirement plan for a TTS S-Corp must be established (opened) with a financial intermediary before year-end. Plan to pay (or fund) the 2018 elective deferral amount up to a maximum $18,500 (or $24,500 if age 50 or older) executed with December payroll by Jan. 31, 2019. Plan to pay (fund) the 25% profit-sharing plan (PSP) portion of the S-Corp Solo 401(k) up to a maximum of $36,500, by the due date of the 2018 S-Corp tax return, including extensions, which means Sept. 15, 2019. The maximum PSP contribution requires wages of $146,000 ($36,500 divided by 25% defined contribution rate.) A SEP IRA is less attractive; it doesn’t have a 100%-deductible elective deferral, which means a similar contribution requires more compensation that is subject to Medicare taxes.

Cryptocurrencies: Report realized capital gains and losses for all sales of cryptocurrencies. The IRS classifies cryptocurrencies as intangible property. Include crypto-to-altcoin sales, crypto-to-currency sales, hard forks if you have control and there is a fair market value and purchases of items using crypto. Many crypto traders inappropriately deferred 2017 income on crypto-to-altcoin sales claiming Section 1031 like-kind deferral treatment. TCJA restricted Section 1031 usage to real property only starting in 2018. Bitcoin, Ethereum and other crypto are not securities so wash sale loss rules, and Section 475 MTM elections do not apply. The SEC recently stated that some ICOs and tokens are securities, but not Bitcoin and Ethereum. The IRS has not changed its designation as intangible property, and I expect updated crypto tax guidance from the IRS soon. (See the cryptocurrencies section of our Website.)

With the 2018 crash in cryptocurrency prices, now before year-end 2018 is an excellent time to sell losing crypto positions to realize capital losses which offset capital gains on securities (“tax loss selling”). The wash sale loss rules on securities don’t apply on crypto because it is intangible property, not a security. You can repurchase the crypto positions within hours after booking the tax loss.

Fill in the gaps in tax brackets

If you own an investment portfolio, you have the opportunity to reduce capital gains taxes via “tax loss selling.” You may wish to sell winning positions to accelerate income, perhaps to use up a capital loss carryover or an NOL. TTS traders want a “clean slate” — meaning no capital loss carryovers — so they can make a Section 475 election in the subsequent tax year.

If you are in the lowest two “ordinary” tax brackets for 2018 (10% or 12%), try to take advantage of the 0% long-term capital gains rate. The 12% ordinary income bracket applies on taxable income up to $37,800/$77,400 (single/married). For example, if your single taxable income is $30,000, you can realize $7,500 of long-term capital gains with zero federal tax.

If you realized significant short-term capital gains year-to-date in 2018 and had open positions with substantial unrealized capital losses, you should consider selling (realizing) some of those losses to reduce 2018 capital gains taxes. Don’t repurchase the losing position 30 days before or after, as that would negate the tax loss with wash-sale-loss rules.

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

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

Taxpayers should review tax brackets, Social Security and retirement contribution limits, standard deductions, and more. See Tax Rates, other tax charts, and analysis of TCJA at Tax Foundation. There are differences in filing status.

We recommend discussing year-end planning with your tax adviser by early December. Don’t wait until the last minute! If our firm prepared your 2017 tax return, your Client Copy includes a “Tax Reform Impact Summary,” which shows the impact of TCJA on your 2017 file. Our CPAs and I hope to hear from you soon.

Darren L. Neuschwander CPA contributed to this blog post. 

Webinar: Traders Have Unique Issues For Year-End Planning. Come to the Dec. 5, 2018 event or watch the recording after.

To Get The Most Out Of Tax Reform, Traders Need To Act Fast

October 30, 2018 | By: Robert A. Green, CPA | Read it on

Actions are required before year-end to cash in on some of the tax benefits of the 2017 Tax Cuts and Jobs Act (TCJA).

Defer income and accelerate tax deductions
Consider the time-honored strategy of deferring income and accelerating tax deductions if you don’t expect your taxable income to decline in 2019. Tax rates are the same for 2019, although the IRS adjusts tax brackets for inflation each year. Enjoy the time-value of money with income deferral.

Year-end tax planning is a challenge for traders because they have wide fluctuations in trading results, making it difficult to forecast their income. Those expecting to be in a lower tax bracket in 2019 should consider income deferral strategies. Conversely, a 2018 TTS trader with ordinary losses, hoping to be in a higher tax bracket in 2019 should consider income acceleration strategies.

If you have trader tax status in 2018, consider accelerating trading business expenses, such as purchasing business equipment with full expensing.

Don’t assume that accelerating itemized deductions is also a smart move; there may be two problems. TCJA suspended and curtailed various itemized deductions, so there is no sense in expediting a non-deductible item. Even with the acceleration of deductible expenses, many taxpayers will be better off using the standard deduction of $24,000 married, $12,000 single, and $18,000 other taxpayers — these are roughly doubled by TCJA. There is an additional standard deduction of $1,300 for the aged or the blind. If itemized deductions are below the standard deduction, consider a strategy to “bunch” itemized deductions into one year and take the standard deduction in other years.

Accelerate income and defer certain deductions
A TTS trader with substantial losses that are not subject to the capital loss limitation should consider accelerating income to soak up the business loss, instead of having an NOL carryover. TCJA repealed the two-year NOL carryback rule starting in 2018. Try to advance enough income to fully utilize the standard deduction and take advantage of lower tax brackets. Be sure to stay below the thresholds for unlocking various types of AGI-dependent deductions and credits.

Roth IRA conversion: Convert a traditional IRA into a Roth IRA before year-end to accelerate income. The conversion income is taxable in 2018, but you avoid the 10% excise tax on early withdrawals. One concern is that TCJA repealed the recharacterization (reversal) option. There isn’t an income limit for making Roth IRA conversions, whereas, there is for making contributions.

Sell winning positions: Another way traders can accelerate income is to sell open winning positions to realize short-term capital gains. Consider selling long-term capital gain positions, too. In the bottom two ordinary tax rates of 10% and 12%, the long-term capital gains tax rate is zero.

Business expenses, and itemized deduction vs. standard deduction

Business expenses: TTS traders are entitled to deduct business expenses and home-office deductions from gross income. The home office deduction requires income, except for the mortgage interest and real estate portion. The SALT cap on state and local taxes does not apply to the home office deduction. TCJA expanded full expensing of business property; traders can deduct 100% of these costs in the year of acquisition, providing they place the item into service before year-end. If you have TTS in 2018, considering going on a shopping spree before Jan. 1. No sense deferring TTS expenses, because you cannot be sure you will qualify for TTS in 2019.

Itemized deductions: TCJA suspended all “miscellaneous itemized deductions subject to the 2% floor” including investment fees and expenses, unreimbursed employee business expenses, and tax compliance fees. (See Investment Fees Are Not Deductible But Borrow Fees Are.)

Net investment tax: Investment fees and expenses remain deductible for calculating net investment income for the 3.8% net investment tax (NIT) on unearned income. NIT only applies to individuals with net investment income (NII) and modified adjusted gross income (AGI) exceeding $200,000 (single), $250,000 (married filing jointly), or $125,000 (married filing separately). The IRS does not index these thresholds for inflation. (Learn more on my website.)

Retirement plans: If you engage outside investment advisors for managing your retirement accounts, try to pay the advisors from traditional retirement plans, but not Roth IRAs. An expense in a traditional tax-deferred retirement plan is equivalent to a tax-deferred deduction. (Roth IRAs are permanently tax-free, so you don’t need deferred deductions in Roth plans.) A postponed deduction is better than a suspended itemized deduction, which is not deductible. Some brokerage firms might not cooperate unless you engage the firm’s wealth management service. Consider a retirement plan custodian or intermediary who is more accommodating on these expense payments. Don’t allow your retirement plan to pay investment fees to you, or close family members: It’s self-dealing, a prohibited transaction, which might blow up your retirement plan. If you don’t have TTS, consider trading in your retirement plan, instead of taxable accounts.

Employee business expenses: Ask your employer if they have an “accountable plan” for reimbursing employee-business expenses. You must “use it or lose it” before year-end. TTS traders allocate a portion of tax compliance fees to TTS business expense.

Short-selling stock borrow fees, remain deductible under TCJA as “other miscellaneous deductions” on Schedule A (Itemized Deductions) line 28. If you qualify for TTS, short-selling expenses are business expenses. (See Investment Fees Are Not Deductible But Borrow Fees Are.)

Investment interest expense: TCJA did not change investment-interest expense rules: This itemized deduction is limited to investment income, and the excess is carried over to the subsequent tax year(s). TTS traders deduct margin interest expenses on trading positions as a business expense. TCJA curtailed business interest expenses for larger companies only.

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

Estimated income taxes: If you already reached the SALT cap, you don’t need to prepay 2018 state estimated income taxes by Dec. 31, 2018. Pay federal and state estimated taxes owed by Jan. 15, 2019, with the balance of your tax liabilities payable by April 15, 2019. (You can gain six months of additional time by filing an automatic extension on time, but late-payment penalties will apply.)

AMT: In prior years, taxpayers had to figure out how much they could prepay their state without triggering alternative minimum tax (AMT) since state taxes are not deductible for AMT taxable income. It’s easier for 2018 with SALT capped at $10,000 and because TCJA raised the AMT exemption. If you are subject to AMT for 2018, then don’t accelerate AMT preference items.

Standard deduction: TCJA roughly doubled the standard deduction and suspended and curtailed several itemized deductions. Many more taxpayers will use the standard deduction for 2018, which might simplify their tax compliance work. For convenience sake, some taxpayers may feel inclined to stop tracking itemized deductions because they figure they will use the standard deduction. Don’t overlook the impact of these deductions on state tax return where you might get some tax relief for itemizing deductions. Plus, certain repeals and curtailed itemized deductions might be deductible on other parts of your tax return.

20% deduction on qualified business income
This deduction might be one of the most crucial TCJA changes to consider for 2018, and you should take action before year-end.

The IRS recently issued proposed reliance regulations (Proposed §1.199A) for the TCJA’s 20% deduction on qualified business income (QBI) in pass-through entities. The proposed regulations confirm that traders eligible for TTS are a “specified service activity,” which means if their taxable income is above an income cap, they won’t get a QBI deduction. The taxable income (TI) cap is $415,000/$207,500 (married/other taxpayers). The phase-out range below the cap is $100,000/$50,000 (married/other taxpayers), in which the QBI deduction phases out for specified service activities. The W-2 wage and property basis limitations also apply within the phase-out range. Hedge funds eligible for TTS and investment managers are specified service activities.

QBI likely includes Section 475 ordinary income, whereas, TCJA expressly excluded capital gains and losses from it. (See How Traders Can Get 20% QBI Deduction Under IRS Proposed Regulations.)

TCJA favors non-service businesses, which are not subject to an income cap. The W-2 wage and property basis limitations apply above the TI threshold of $315,000/$157,500 (married/other taxpayers). The IRS will adjust TI income cap, phase-out range, and the threshold for inflation in each subsequent year. Calculate QBI on an aggregate basis.

You might be able to increase the QBI deduction with smart year-end planning. If your taxable income falls within the phase-out range for a specified service activity, you might need wages, including officer compensation, to avoid a 50% wage limitation on the QBI deduction. Try to defer income to get under the TI threshold and use up less of the phase-out range.

Consult your tax advisor well before year-end. The QBI deduction is complicated, and questions are pending with the IRS. Accountants are going to be very busy in December, so get on their schedule early.

Married couples should compare filing joint vs. separate
Each year, married couples choose between “married filing joint” (MFJ) vs. “married filing separate” (MFS). TCJA fixed several inequities in filing status, including the tax brackets by making single, MFJ, and MFS brackets equivalent, except for divergence at the top rate of 37%. See the ordinary tax brackets: MFJ/MFS enter the top 37% rate at $600,000/$300,000 vs. $500,000 for single. TCJA retains the marriage penalty at the top rate only.

Married couples may be able to improve QBI deductions, AGI and other income-threshold dependent deductions, and credits with MFS in 2018. It’s wise to enter each spouse’s income, gain, loss and expense separately and have the tax software compare MFJ vs. MFS. In a community property state, there are special rules for allocating income between spouses.

Miscellaneous considerations for individuals
• Becoming familiar with all of the changes in TCJA is crucial. TaxFoundation.Org is an excellent resource.
• Note inflation adjustment increases to rate brackets and more.
• Consider estimated tax payment rules including the safe-harbor exceptions. If you accelerate income, you may need to pay Q4 2018 estimated taxes by Jan. 15, 2019.
• Alternatively, increase tax withholding on wages to avoid estimated tax underpayment penalties.
• If you still need to avoid estimated tax underpayment penalties, arrange a rollover distribution from a qualified retirement plan with significant tax withholding before year-end. Next, roll over the gross amount into a rollover IRA. The result is zero income and avoidance of an estimated tax penalty.
• Sell off passive-loss activities to unlock and utilize suspended passive-activity losses.
• Maximize contributions to retirement plans. That lowers AGI, which can unlock more of a QBI deduction, reduce net investment tax, and unlock AGI dependent benefits.
• The IRS has many obstacles to deferring income including passive-activity loss rules, a requirement that certain taxpayers use the accrual method of accounting and limitations on charitable contributions. TCJA allows more businesses to use the cash method.
• Consider a charitable remainder trust to bunch charitable contributions for itemizing deductions. (Ask Fidelity or Schwab about it.)
• Donate appreciated securities to charity: You get a charitable deduction at the FMV and avoid capital gains taxes. (This is a favorite strategy by billionaires, and you can use it, too.)
• Retirees must take required minimum distributions by age 70½. Per TCJA, consider directing your retirement plan to make “qualified charitable distributions” (QCD). That satisfies the RMD rule with the equivalent of an offsetting charitable deduction, allowing you to take the standard deduction rather than itemize.
• TCJA improves family tax planning: Consider “kiddie tax” rules with increased gift exclusions. Section 529 qualified tuition plans now can be used to pay for tuition at an elementary or secondary public, private or religious school, up to $10,000 per year; the annual gift exclusion is $15,000; the unified credit for estate tax is significantly higher at $11.18 million per person, and “step-up in basis” rules still avoid capital gains taxes on inherited appreciated property. TTS traders should also consider hiring adult children as employees.
• Make sure to fund FSAs and HSAs before year-end fully.

See my next blog post for more info: To Save Taxes, Traders Need To Deal With Unique Issues Before Year-End.

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

Webinar: How Traders Can Save Taxes Before Year-End. Come to the Nov. 7, 2018 event or watch the recording after.

How Traders Can Get The 20% QBI Deduction Under New Law

January 12, 2018 | By: Robert A. Green, CPA | Read it on

Like many small business owners, traders eligible for trader tax status (TTS) are considering to restructure their business for 2018 to take maximum advantage of the “Tax Cuts and Jobs Act” (Act). Two tax benefits catch their eye: The 20% deduction on pass-through qualified business income (QBI), and the C-Corp 21% flat tax rate.

The 20% QBI deduction
There are two components for obtaining a 20% deduction on QBI in a pass-through business.

1. QBI: I’ve made some excellent arguments over the past few months in my blog posts for including Section 475 ordinary income for TTS traders in QBI, but the Act did not expressly confirm that position. I am confident that Section 475 is part of QBI, so consider that election for 2018. The law only counts QBI from domestic sources, which may mean trading activity in U.S. markets, but not foreign markets and exchanges.

I’ve also suggested that TTS “business-related” capital gains should be includible in QBI since the Act excludes “investment-related” short-term and long-term capital gains. For now, I assume the IRS may reject all capital gains.

2. SSA vs. non-SSA: Assuming a TTS trader has QBI on Section 475 MTM ordinary income, the calculation depends on whether the business is a specified service activity (SSA) or not. I’ve made some arguments on why a trading business could be a non-SSA but based on the new tax law, TTS traders should assume their business is an SSA.

For example, if a TTS trader has 2018 taxable income under the SSA threshold of $157,500 single and $315,000 married, and assuming the trader has Section 475 ordinary income, then the trader would get a 20% deduction on either QBI or taxable income less net capital gains (whichever is lower). The 20% deduction is phased out above the SSA threshold by $50,000 single and $100,000 married. If taxable income is $416,000, above the phase-out range, the married couple gets no QBI deduction at all.

A QBI deduction is on page two of the Form 1040; it’s not an adjusted gross income (AGI) deduction or a business expense from gross income.

An owner of a non-SSA business, like a manufacturer, is entitled to the 20% deduction without a taxable income limitation, although there is a 50% wage limitation, or alternative 25% wage limitation with 2.5% qualified property factor, above the SSA income threshold. (See Traders Should Be Entitled To The Pass-Through Tax Deduction.)

TTS trading with Section 475 ordinary income
TTS is a hybrid concept: It gives “ordinary and necessary” business expenses (Section 162). A trader in securities and or commodities (Section 1256 contracts) eligible for TTS may elect Section 475(f) mark-to-market (MTM)) accounting, which converts capital gains and losses into ordinary gains and losses.

Steven Rosenthal, Senior Fellow, Urban-Brookings Tax Policy Center, weighed in for my prior blog post and again recently: “Section 475 treats the gain as ordinary income,” he says. “Section 64 provides that gain that is ordinary income shall not be treated as gain from the sale of a capital asset.” Mr. Rosenthal thinks Section 475 ordinary income is QBI under the new tax law for this reason and “because it’s not on the QBI exclusion list.” Rosenthal pointed out there is no statutory definition of “business income.”

In the new law, QBI excludes a list of investment items including short- and long-term capital gains and losses. I don’t see how an IRS agent could construe Section 475 ordinary income as capital gains.

I look forward to the Congressional analysis in the”Blue Book” for the General Explanation of the Act — hopefully, this will shed further light on my questions. Some traders may prefer to wait for IRS regulations on these Act provisions and other types of IRS guidance. Hopefully, big law firms will form a consensus opinion on this issue for their hedge fund clients, soon.

Congress may not have envisioned the pass-through deduction for hedge funds and TTS trading companies, and they may fix things through interpretation or technical correction to prevent that outcome.

Trading in a C-Corp could be costly
Don’t only focus on the federal 21% flat tax rate on the C-Corp level; there are plenty of other taxes, including capital gains taxes on qualified dividends, potential accumulated earnings tax, a possible personal holding company tax penalty, and state corporate taxes in 44 states.

If you pay qualified dividends, there will be double taxation with capital gains taxes on the individual level — capital gains rates are 0%, 15% or 20%. If you avoid paying dividends, the IRS might assess a 20% accumulated earnings tax (AET). If you have trading losses, significant passive income, interest, and dividends, it could trigger personal holding company status with a 20% tax penalty. (See my blog post How To Decide If A C-Corp Is Right For Your Trading Business.)

How to proceed
For 2018, TTS traders should consider a partnership or S-Corp for business expenses, and a Section 475 election on securities for exemption from wash sale losses and ordinary loss treatment (tax loss insurance). Consider a TTS S-Corp for employee benefit plan deductions including health insurance and a high-deductible retirement plan, since a TTS spousal partnership or TTS sole proprietor cannot achieve these deductions. Consider this the cake.It puts you in position to potentially qualify for a 20% QBI deduction on Section 475 or Section 988 ordinary income in a TTS trading pass-through entity – icing on the cake. If a TTS trader’s taxable income is under the specified service activity (SSA) threshold of $315,000 (married), and $157,500 (other taxpayers), he or she should get the 20% QBI deduction in partnerships or S-Corps. Within the phase-out range above the threshold, $100,000 (married) and $50,000 (other taxpayers), a partial deduction. QBI likely includes Section 475 and Section 988 ordinary income and excludes capital gains (Section 1256 contracts and cryptocurrencies). It might be a challenge for a TTS sole proprietor to claim the pass-through deduction because Schedule C has trading expenses only; trading gains are on other tax forms.

I suggest you consult with me about these issues soon.

Darren Neuschwander, CPA, and Roger Lorence, Esq., contributed to this post. 

How To Decide If A C-Corp Is Right For Your Trading Business

January 9, 2018 | By: Robert A. Green, CPA | Read it on

When taking into account the Tax Cuts and Jobs Act for 2018, don’t focus solely on the federal 21% flat tax rate on the C-Corp level. There are plenty of other taxes, including capital gains taxes on qualified dividends, state corporate taxes in 44 states, and accumulated earnings tax assessed on excess retained earnings.

When a C-Corp pays qualified dividends to the owner, double taxation occurs with capital gains taxes on the individual level (capital gains rates are 0%, 15% or 20%). If an owner avoids paying sufficient qualified dividends, the IRS is entitled to assess a 20% accumulated earnings tax (AET). It’s a fallacy that owners can retain all earnings inside the C-Corp.

C-Corp vs. individual tax rates
Starting in 2018 under the new tax law, C-Corps may benefit from a 21% flat tax rate vs. individual graduated rates of 10% to 37%. Don’t confuse your tax bracket with your tax rate, which is less. For example, the average individual tax rate is 27% for a married couple entering the top 37% tax bracket of $600,000 and 30% for a single filer approaching the top bracket of $500,000; so the actual rate difference is 6% and 9% in these two examples.

Upper-income traders may also have individual 3.8% net investment tax (NIT) on net investment income (NII). NIT applies on NII over the modified AGI threshold of $250,000 (married) and $200,000 (single). Adding this in, the difference between the flat rate could be 9.8% and 12.8% in our example.

Traders don’t owe self-employment (SE) tax, so I don’t factor that into the equation. Other small business owners have SE or payroll tax in pass-throughs but can avoid it with a C-Corp. Let say the C-Corp has a 10% rate advantage for high-income traders and a lower or no benefit for middle- to lower-income traders.

Now come all the haircuts that can lead to adverse taxes and make the C-Corp a costlier choice for a trader. Double taxation on the federal level can wipe out that savings with a 15% or 20% capital gains tax on “qualified dividends.” Double taxation on the state level can lead to a C-Corp owner paying higher taxes than with a pass-through entity. There are potential 20% accumulated earnings taxes and personal holding company tax penalties. Look before you leap into a C-Corp and consult a trader tax expert.

C-Corp double taxation with qualified dividends
A C-Corp pays taxes first on the entity level, and the owners owe taxes a second time on the individual level on dividends and capital gains.

When C-Corps make a cash or property distribution to owners, it’s a taxable dividend if there are “earnings and profits” (E&P). If the individual holds the C-Corp stock for 60 days, it’s a “qualified dividend,” subject to lower long-term capital gains rates of 0%, 15%, and 20%. The 0% capital gains bracket applies to taxable income up to $77,200 (married) and $38,600 (single). A 15% dividends tax offsets the difference in individual vs. corporate tax rates.

State double taxation can ruin the C-Corp strategy
According to Tax Foundation, “Forty-four states levy a corporate income tax. Rates range from 3 percent in North Carolina to 12 percent in Iowa.” (See your state on the Tax Foundation map, State Corporate Income Tax Rates and Brackets for 2017.) States don’t use lower capital gains rates for taxing individuals; they treat qualified dividends as ordinary income.

A C-Corp is a wrong choice for a trader entity in California with an 8.84% corporate tax rate, but it could be the right choice for a high-income trader in Texas without corporate taxes if he or she retains earnings and can successfully avoid IRS 20% accumulated earnings tax (more on this to come). The Texas 0.75% franchise tax applies to all types of companies with limited liability, including LLCs, and C-Corps, and the “No Tax Due Threshold” is $1.11 million. Most traders won’t trigger the Texas franchise tax.

Don’t try to avoid filing a C-Corp tax return in your resident state. You are entitled to form your entity in a tax-free state, like Delaware, but your home state probably requires registration of a “foreign entity,” if it operates in your state. Setting up a mail forwarding service in a tax-free state does not achieve nexus, whereas, conducting a trading business from your resident state does.

The new tax law capped state and local income, sales, and property taxes (SALT) itemized deductions at $10,000 per year. It does not suspend SALT deductions paid by C-Corps, but that expense is only the double-taxed portion; the individual SALT on qualified dividends is still limited.

Accumulated earnings tax
If the C-Corp does not pay dividends from E&P, the IRS can assess a 20% “accumulated earnings tax” (AET) if the C-Corp E&P exceeds a threshold and company management cannot justify a business need for retaining E&P. The IRS is trying to incentivize C-Corps to pay dividends to owners. The IRS AET threshold is $250,000, or $150,000 for a personal service corporation. (See Section 533.)

If the IRS treats a trader tax status (TTS) trading company as an “investment company,” then it may assess 20% AET on all E&P and therefore undermine the C-Corp strategy for traders. But I don’t think a TTS trading company with Section 475 ordinary income is an investment company. A TTS trading C-Corp needs to demonstrate a business need for E&P above the $250,000 threshold.

“AET requires the corporation to have adopted a plan for business expansion that will require substantial additional capital,” says Roger Lorence, a tax attorney in the New York City area who specializes in hedge fund tax. “The plan must be in writing and adopted by the Board; it must refer to the analysis of the business, the need for expansion, the need for more capital, and include a timeline for implementation.”

Arguing the C-Corp needs more trading capital for growing profits is likely not an acceptable reason for avoiding dividends. Sufficient reasons might include buying exchange seats, hiring traders and back office staff, and purchasing more equipment and automated trading systems. Over a period, the C-Corp must implement its formal plan. Otherwise, the IRS won’t respect the policy. Many one-person TTS trading companies don’t have these types of expansion plans, and they likely won’t succeed in defending against an AET assessment. Previously, I pointed out a C-Corp might be suitable for a high-income trader, but they would probably exceed the AET threshold in the first year.

Personal holding company tax penalty
“Personal holding company” (PHC) status is triggered when a closely held C-Corp has at least 60% of gross income coming from certain passive income (including interest, dividends, rents, and royalties), and has not made sufficient distributions to shareholders. The IRS is entitled to assess a 20% PHC tax penalty. The new tax law did not revise the PHC rules, and some tax experts think Congress should have tightened them.

Capital gains and Section 475 ordinary income are not passive income, so a successful TTS trader C-Corp will likely not meet the definition. However, if a trader incurs a net trading loss for a given year, then passive income might exceed 60% of gross income and trigger a PHC penalty. If a trader has substantial passive income, don’t hold those positions in a C-Corp.

Officer compensation avoids double taxation
Historically, C-Corps paid higher officer compensation to avoid the 35% C-Corp tax rate. But now, C-Corps may want the 21% C-Corp tax rate over the individual tax rates up to 37% on wage income instead.

C-Corp Cons
1. No lower 60/40 capital gains tax rates on Section 1256 contracts.
2. Ordinary losses do not pass-through to the owner’s tax return, missing an opportunity for immediate tax savings against other income. The new law has an excess business loss limitation of $500,000 (married) and $250,000 (single), and it repealed the NOL carryback, only allowing carryforwards.
3. A C-Corp investment company without TTS may not deduct investment expenses. The Act suspends miscellaneous itemized deductions for individuals, which includes investment expenses. Don’t try to house investments in a C-Corp; it might be deemed a PHC.
4. If you liquidate a C-Corp to realize the capital loss and ordinary loss trapped inside it, you might qualify for Section 1244 ordinary loss treatment up to $100,000 (married) or $50,000 (single), with the remainder of the loss treated as a capital loss. Therefore, you could be stuck with a capital loss carryover. Per Section 1244, “a corporation shall be treated as a small business corporation if the aggregate amount of money and other property received by the corporation for stock, as a contribution to capital, and as paid-in surplus, does not exceed $1,000,000.” Conversely, with a pass-through entity and Section 475 ordinary loss treatment, the trader would have all ordinary loss treatment.

There are a few good things about C-Corps: A more extensive assortment of fringe benefit plans for owners, and charitable contributions, which some individuals may limit due to the higher standard deduction.

Example: Profitable trader in a tax-free state
Nancy Green, a resident of Texas, consistently makes well over $500,000 net income per year trading securities with Section 475 ordinary income. She has officer compensation of $146,000 to maximize her company Solo 401(k) retirement plan contribution of $55,000 (under age 50).

With an S-Corp, her 2018 gross income is $646,000 ($500,000 K-1 income and $146,000 wages), she takes a $25,000 itemized deduction, which makes her taxable income $621,000. Nancy is over the $207,500 taxable income threshold for a specified service activity, so she does not qualify for the Act’s 20% deduction on qualified business income (QBI) in a pass-through. Her 2018 federal income tax is $195,460. Her marginal tax bracket is the top 37% rate, and her average tax rate is 31% — 10% above the C-Corp flat rate of 21%. She also owes 3.8% NIT on $300,000 ($500,000 K-1 income less the modified AGI threshold of $200,000), which equals $11,400. Nancy’s total federal tax liability using an S-Corp is $206,860.

With a C-Corp, Nancy’s individual tax return gross income is $146,000 from wages, and she takes a $25,000 itemized deduction, which lowers her taxable income to $121,000. Her individual federal income tax is $23,330, which is 19.3% of taxable income. Nancy does not owe NIT in this case. (This assumes she has no qualified dividends from the C-Corp.) The federal corporate tax is $105,000 ($500,000 times 21%). With her individual tax paid using the C-Corp, her total federal tax is $128,330.

The C-Corp structure delivers 2018 federal tax savings of $78,530 vs. the S-Corp. There is no corporate or individual income tax in Texas, and she did not exceed the franchise tax threshold, so the savings with the C-Corp can be significant. It also depends on whether or not she pays qualified dividends or has an IRS 20% AET assessment.

If Nancy needs distributions for living expenses, she has two choices:
1. Pay additional wages, which only are subject to Medicare tax of 2.9%, reducing C-Corp net income at a 21% rate, and subjecting her to more individual tax at 24% and 32% marginal rates. (This might be the more attractive option.)
2. Pay qualified dividends taxed at 15%, plus some 3.8% NIT, which does not reduce C-Corp taxes. Her overall savings will decline, but it’s still substantially positive vs. the S-Corp. For example, a qualified dividend of $300,000 would cause $45,000 of capital gains taxes and $9,348 of NIT. Net federal tax savings from using the C-Corp vs. the S-Corp would be $24,182.

If Nancy moves to California, the C-Corp is not a good idea because California has an 8.84% corporate tax rate and with double taxation, the C-Corp savings disappears. Like many other states, California treats all income as ordinary income; it does not distinguish qualified dividends or long-term capital gains. In Nancy’s case, California’s corporate tax would be $44,200 ($500,000 x 8.84% rate), plus individual taxes on $300,000 qualified dividends would be approximately $28,000. A C-Corp in California would lead to much higher federal and state taxes vs. using a dual entity solution, where a trading partnership and S-Corp management company are used to avoid the state’s 1.5% franchise tax on S-Corps.

The 800-pound gorilla in the room is the 20% accumulated earnings tax (AET), and under what conditions the IRS may assess it on a trading business C-Corp. Nancy can tell the IRS she is a TTS trader entitled to retain earnings up to $250,000. Her C-Corp made $500,000 and paid qualified dividends of $300,000, so she kept $200,000 of profits inside the C-Corp. The IRS allows up to $250,000, so she should be fine for 2018, but what about 2019? Does Nancy have a written plan that is feasible for keeping a war chest of earnings over the $250,000 threshold? Probably not, and that could render the C-Corp tax advantage a mirage for her and others in a similar boat.

I suggest traders consult with me to discuss their 2018 projections and see which shoe fits best: a partnership, S-Corp or C-Corp, or some combination, thereof.



The Tax Cut Suspended Many Deductions For Individuals

December 29, 2017 | By: Robert A. Green, CPA | Read it on

The Tax Cuts and Jobs Act suspended or trimmed several cherished tax deductions that individuals count on for savings. So, exactly how bad is it and what can you do about it?

The lion’s share of the $1.5-trillion tax cut goes to corporations (C-Corps). The Act lowered the corporate rate from 34% to 21%, a flat rate starting in 2018 and switched from a global income-tax regime to a territorial tax system. The Act made most C-Corp tax cuts permanent, giving multinational corporations confidence in long-term planning.

Democrats lambaste the Act because most of the individual tax cuts expire at the end of 2025. Republicans probably expect Democrats to cooperate in making the individual tax cuts permanent before the 2026 mid-term elections.

Individual changes take effect in 2018
The Act brings forth a mix of negative and positive changes for individuals. The highlights include:

  • Lower tax rates in all seven brackets to 10%, 12%, 22%, 24%, 32%, 35%, and 37%; Four tax brackets for estates and trusts: 10%, 24%, 35%, and 37%;
  • Standard deduction raised to $24,000 married, $18,000 head-of-household, and $12,000 for all other taxpayers, adjusted for inflation;
  • An expanded AMT exemption to $109,400 married and $70,300 single.
  • Many itemized deductions and AGI deductions suspended or trimmed (more on this below);
  • Personal exemptions suspended;
  • Child tax credit increased;
  • New 20% deduction for pass-through income with many limitations;
  • Pease itemized deduction limitation suspended;
  • Obamacare shared responsibility payment lowered to zero for non-compliance with the individual mandate starting in 2019;
  • Children’s income no longer taxed at the parent’s rate; kids must file tax returns to report earned income, and unearned income is subject to tax using the tax brackets for trusts and estates.

State and local taxes capped at $10,000 per year
The most contentious deduction modification is to state and local taxes (SALT). After intense deliberations, conferees capped the SALT itemized deduction at $10,000 per year. The Act allows any combination of state and local income, sales or domestic property tax. SALT may not include foreign real property taxes.

The Act prohibited a 2017 itemized deduction for the prepayment of 2018 estimated state and local income taxes. Individuals are entitled to pay and deduct 2017 state and local income taxes by year-end 2017.

The Act permits a 2017 itemized deduction for the advance payment of 2018 real property taxes, providing the city or town assessed the taxes before 2018. For example, a taxpayer could pay real property taxes before Dec. 31, 2017, and deduct it in 2017, on an assessment for the fiscal year July 1, 2017, to June 30, 2018. These IRS rules are similar for all prepaid items for cash basis taxpayers. (See IRS Advisory: Prepaid Real Property Taxes May Be Deductible in 2017 if Assessed and Paid in 2017.)

Consider that SALT is an AMT preference item; it’s not deductible for AMT taxable income.  Many upper-income and middle-income individuals fall into the AMT zone, so they don’t get a full SALT deduction. The Pease itemized deduction limitation also trimmed the SALT deduction for 2017 and prior years.

Many business owners deduct home-office expenses (HO), which include a portion of real property taxes and that allocation is not subject to the $10,000 SALT limit, and the home office deduction is not an AMT preference item. Here’s a tip: Report 100% of real property taxes on home office form 8829, to maximize the HO deduction. Deduct state and local income taxes, and the remainder of real property taxes, to reach the $10,000 SALT limit on Schedule A. When you factor in a more substantial standard deduction for 2018, many individuals may not lose as much of their SALT deduction as they fear. With lower individual tax rates, they might still end up with an overall tax cut.

The Act does not permit a pass-through business owner to allocate SALT to the business tax return. For example, an S-Corp cannot reimburse its owner for his or her individual state and local income taxes paid in connection with that pass-through income.

SALT is still allowed as a deduction from net investment income for calculating the 3.8% Obamacare net investment tax.

High-tax states are fighting back against the SALT cap. State and local jurisdictions are setting up 501(c)(3) charitable organizations to fund state and local social costs, including public schools. Residents would make charitable contributions to the state 501(c)(3) and receive credit for real property and or state income taxes. This type of restructuring would convert non-deductible SALT payments into tax-deductible charitable contributions. It will be difficult to arrange, and the IRS may object, so don’t hold your breath. High-tax states have significant transfer payments to people in need, and it seems appropriate to consider it charity.

Medical expenses modified
The Act retained the medical-expense itemized deduction, which is allowed if it’s more than the AGI threshold. In 2017, the AGI threshold was 10% for taxpayers under age 65, and 7.5% for age 65 or older. The Act uses a 7.5% AGI threshold for all taxpayers in 2018, and a 10% threshold for all taxpayers starting in 2019. Medical expenses are an AMT preference item.

Mortgage debt lowered on new loans
As of Dec. 15, 2017, new acquisition indebtedness is limited to $750,000 ($375,000 in the case of married taxpayers filing separately), down from $1 million, on a primary residence and second home. Mortgage debt incurred before Dec. 15, 2017 is subject to the grandfathered $1 million limit ($500,000 in the case of married taxpayers filing separately). If a taxpayer has a binding written contract to purchase a home before Dec. 15, 2017 and to close by Jan. 1, 2018, he or she is grandfathered under the previous limit. Refinancing debt from before Dec. 15, 2017 keeps the grandfathered limit providing the mortgage is not increased.

The conference report “suspends the deduction for interest on home equity indebtedness” starting in 2018. (IRS news release IR-2018-32, Feb. 21, 2018, Interest on Home Equity Loans Often Still Deductible Under New Law. If you stay within the $750,000 new acquisition indebtedness, and home equity loan funds are used to improve the home it’s borrowed on, then the home equity interest is deductible. Conversely, if you use the HELOC funds for other purposes, it’s not deductible.)

As with SALT, the home office mortgage interest deduction is not subject to Schedule A limits. IRS instructions for home office Form 8829 state, “If the amount of home mortgage interest or qualified mortgage insurance premiums you deduct on Schedule A is limited, enter the part of the excess that qualifies as a direct or indirect expense. Do not include mortgage interest on a loan that did not benefit your home (explained earlier).”

Investment expenses suspended
The Act has many provisions impacting investors, including suspension of miscellaneous itemized deductions, which include investment expenses, starting in 2018. The Act did not repeal investment interest expense. (See The Tax Cut Impacts Investors In Negative And Positive Ways.)

Investment expenses are still allowed as a deduction from net investment income for calculating the 3.8% Obamacare net investment tax. Retirement plans, including IRAs, are also entitled to deduct investment expenses, although it may be difficult to arrange with the custodian.

Unreimbursed employee business expenses suspended
The Act suspends unreimbursed employee business expenses deducted on Form 2106. Speak with your employer about implementing an accountable reimbursement plan and “use it or lose it” before year-end 2018. See a list of these items below.

Tax preparation and planning fees suspended
Miscellaneous itemized deductions include tax compliance (planning and preparation) fees. If you operate a business, ask your accountant to break down their invoices into individual vs. business costs. The business portion is allowed as a business expense.

Miscellaneous itemized deductions suspended
See the complete list of suspended miscellaneous itemized deductions in the Joint Explanatory Statement p. 95-98. Here are the highlights.

Expenses for the production or collection of income:

  • Clerical help and office rent in caring for investments;
  • Depreciation on home computers used for investments;
  • Fees to collect interest and dividends;
  • Indirect miscellaneous deductions from pass-through entities;
  • Investment fees and expenses;
  • Loss on deposits in an insolvent or bankrupt financial institution;
  • Loss on traditional IRAs or Roth IRAs, when all amounts have been distributed;
  • Trustee’s fees for an IRA, if separately billed and paid.

Unreimbursed expenses attributable to the trade or business of being an employee:

  • Business bad debt of an employee;
  • Business liability insurance premiums;
  • Damages paid to a former employer for breach of an employment contract;
  • Depreciation on a computer a taxpayer’s employer requires him to use in his work;
  • Dues to professional societies;
  • Educator expenses;
  • Home office or part of a taxpayer’s home used regularly and exclusively in the taxpayer’s work;
  • Job search expenses in the taxpayer’s present occupation;
  • Legal fees related to the taxpayer’s job;
  • Licenses and regulatory fees;
  • Malpractice insurance premiums;
  • Medical examinations required by an employer;

Occupational taxes;

  • Research expenses of a college professor;
  • Subscriptions to professional journals and trade magazines related to the taxpayer’s work;
  • Tools and supplies used in the taxpayer’s work;
  • Purchase of travel, transportation, meals, entertainment, gifts, and local lodging related to the taxpayer’s work;
  • Union dues and expenses;
  • Work clothes and uniforms if required and not suitable for everyday use; and
  • Work-related education.

Other miscellaneous itemized deductions subject to the 2% floor include:

  • The share of deductible investment expenses from pass-through entities.

Personal casualty and theft losses suspended
The Act suspends the personal casualty and theft loss itemized deduction, except for losses incurred in a federally declared disaster. If a taxpayer has a personal casualty gains, he or she may apply the loss against the gain.

Gambling loss limitation modified
The Act added professional gambling expenses to gambling losses in applying the limit against gambling winnings. Professional gamblers may no longer deduct expenses more than net winnings.

Charitable contribution deduction limitation increased
The Act raised the 50% limitation for cash contributions to public charities, and certain private foundations to 60%. Excess contributions can be carried forward for five years.

The Act retained charitable contributions as an itemized deduction. But, with the suspension of SALT over the $10,000 cap, and all miscellaneous itemized deductions, many taxpayers are expected not to itemize. Some taxpayers won’t feel the deduction effect from making charitable contributions. Consider a bunching strategy, to double up on charity one year to itemize, and contribute less the next year to use the standard deduction. Another bunching strategy is to set up a charitable trust like at Fidelity.

Alimony deduction suspended
The Act suspends alimony deductions for divorce or separation agreements executed in 2019, and the recipient does not have taxable income.

Moving expenses suspended
The Act suspends the AGI deduction for moving expenses, and employees may no longer exclude moving expense reimbursements, either. “Except for members of the Armed Forces on active duty who move pursuant to a military order and incident to a permanent change of station.”

Expanded use of 529 account funds
The Act significantly expands the permitted use of Section 529 education savings account funds. “Qualified higher education expenses” include tuition at an elementary or secondary public, private, or religious school.

There are many other changes, but they are not in the mainstream.

Consider a consultation with Green Trader Tax to discuss the impact of the “Tax Cut And Jobs Act” on your investment activities.

Learn more about the new law and tax strategies for investors, traders and investment managers in Green’s 2018 Trader Tax Guide.

The Tax Cut Impacts Investors In Negative And Positive Ways

December 27, 2017 | By: Robert A. Green, CPA | Read it on

The Tax Cut and Jobs Act impacts investors in many ways, some negative and others positive. Investors with significant investment expenses will decry the suspension of that miscellaneous itemized deduction. Investors in pass-through entities may be surprised they might be entitled to a 20% deduction on qualified business income. These changes under the new law take effect in 2018.

Investment expenses suspended
The new law suspends “all miscellaneous itemized deductions that are subject to the two-percent floor under present law.” These include investment expenses, unreimbursed employee business expenses and tax compliance fees for non-business taxpayers. Miscellaneous itemized deductions are an AMT preference for 2017.

Investment expenses include trading expenses when the trader is not eligible for trader tax status (TTS), and investment advisory fees and expenses paid to investment managers. TTS traders have business expense treatment, so qualification for that status is essential in 2018.

Investment expenses are still allowed as a deduction from net investment income for calculating the 3.8% Obamacare net investment tax. Retirement plans, including IRAs, are also entitled to deduct investment expenses, although it may be difficult to arrange with the custodian.

Family offices
A family office (FO) refers to a wealthy family with substantial investments, across multiple asset classes. The FO hires staff, leases office space, and purchases computers and other fixed assets for its investment operations. An FO produces investment income, and the majority of its operating costs are investment expenses. Potentially losing the investment expense deduction comes as a shock to them. Some FOs are evaluating which activities might qualify for business expense treatment to convert non-deductible investment expenses into business deductions from gross income. Some FOs investing in securities and Section 1256 contracts might ring-fence an active trading program into a separate TTS entity for business expenses. Some of them are not natural TTS traders so that it will be a challenge. Other FOs invest in rental real estate and venture capital, which might have business expense treatment. The goal is to allocate general and administrative expenses to business expenses. Some family offices have outside clients, other than family members, and their management company passes IRS muster for business expense treatment. (See How To Avoid IRS Challenge On Your Family Office.)

Investment interest expenses retained
The present law remains in effect for itemizing investment interest expense. Investment interest expense is deductible up to the extent of investment income. The excess is carried over to the subsequent tax year. (See Form 4952 and instructions.)

Short sellers
If a short seller does not qualify for TTS, the stock borrow fees are considered “other miscellaneous deductions” on Schedule A line 28, which were not suspended by the new tax law. (Some brokers use the term “interest charges” — in reality,  these expenses are stock borrow fees. See Short Selling: How To Deduct Stock Borrow Fees.)

Interest expense modified
TTS traders have business interest deductions for margin interest on TTS trading positions. According to the new law, “The conference agreement follows the House in exempting from the limitation taxpayers with average annual gross receipts for the three-taxable year period ending with the prior taxable year that do not exceed $25 million.” A TTS trading company will likely not trigger the 30% income limitation on business interest expenses.

Carried interest modified
The new law changed the carried interest tax break for investment managers in investment partnerships, lengthening their holding period on profit allocation of long-term capital gains (LTCG) to three years from one year. If the manager also invests capital in the investment partnership, he or she has LTCG after one year on that interest. The three-year rule only applies to the investment manager’s profit allocation — carried interest. Investors still have LTCG based on one year. Investment partnerships include hedge funds, commodity pools, private equity funds and real estate partnerships. Many hedge funds don’t hold securities more than three years, whereas, private equity, real estate partnerships and venture capital funds do.

Investors also benefit from carried interest in investment partnerships. Had the new tax law repealed carried interest outright, investment partnerships without TTS would be stuck passing investment advisory fees (incentive fees) through on Schedule K-1 as non-deductible investment expenses. Carried interest fixes that: The partnership allocates capital gains to the investment manager instead of paying incentive fees. The investor winds up with a lower capital gain amount vs. a higher capital gain coupled with a non-deductible expense. For example, if the investor’s share of net income is $8,000, he or she is happy to report $8,000 as a net capital gain. Without carried interest, the investor would have a $10,000 capital gain and have a $2,000 (20%) non-deductible investment expense.

FIFO is not required
Senate and House conferees canceled the last minute and controversial proposal to require investors to use First-In-First-Out (FIFO) accounting on the sale of securities. FIFO is the default method, but sellers of securities may also use “specific identification.” Investors are entitled to cherry-pick securities positions they sell for capital gains. For example, if an investor sells a portion of Apple shares, he or she may select lots with higher cost basis to realize a lower capital gain. The specific identification method requires a contemporaneously written instruction to the broker and a written confirmation of that execution by the broker. Many taxpayers don’t comply with these rules. For sales of financial products other than securities (such as cryptocurrency), specific identification may not be possible.

Long-term capital gains rates retained
The new tax law maintains the LTCG rates of 0%, 15%, and 20%, and the capital gains brackets are the same for 2017 and 2018. LTCG rates apply if an investor holds a security for more than12 months before sale or exchange. The new law did not change the small $3,000 capital loss limitation against other income, or capital loss carryovers to subsequent tax years. The new law also retains LTCG rates on qualified dividends.

Section 1256 60/40 capital gains rates retained
The 60/40 capital gains rates on Section 1256 contracts are intact, and the new law did not mention any changes to the Section 1256 loss carryback election. At the maximum tax bracket for 2018, the blended 60/40 rate is 26.8% — 10.2% lower than the top ordinary rate of 37%. 

Wash sale loss rules and Section 475
The new law did not fix wash sale loss rules for securities in Section 1091. For more on this lingering issue, see Don’t Solely Rely On 1099-Bs For Wash Sale Loss Adjustments.

The new law does not make any changes to Section 475 MTM ordinary income or loss. It does not change tax treatment for various financial products including spot forex in Section 988, ETFs, ETNs, volatility options, precious metals, swap contracts, foreign futures and more.

Section 1031 like-kind exchanges restricted to real property
The new law limits Section 1031 like-kind exchanges to real property, not for sale. Investors may no longer use Section 1031 to defer income recognition on exchanges in artwork, collectibles, and other tangible and intangible property. Cryptocurrency (coin) is intangible property.

Before 2018, some tax experts indicated it might be possible to defer capital gains and losses on coin-to-coin exchanges as Section 1031 like-kind exchanges. The IRS never said Section 1031 could be used on coin-to-coin trades, and I don’t think it applied to coin-to-coin trading on coin exchanges. I don’t think coin exchanges meet the Section 1031 requirement to act as a qualified intermediary in a multi-party exchange. (See Cryptocurrency Traders Owe Massive Taxes For 2017.)

20% QBI deduction on pass-through entities
The new tax law states, “An individual taxpayer generally may deduct 20 percent of qualified business income from a partnership, S-corporation, or sole proprietorship, as well as 20 percent of aggregate qualified REIT dividends, qualified cooperative dividends, and qualified publicly traded partnership income. Special rules apply to specified agricultural or horticultural cooperatives. A limitation based on W-2 wages paid is phased in above a threshold amount of taxable income. A disallowance of the deduction with respect to specified service trades or businesses is also phased-in above the threshold amount of taxable income.”

The threshold is $315,000 (married) and $157,500 (other taxpayers), and the phase-out range is $100,000 (married) and $50,000 (other taxpayers).

As an example, a securities hedge fund eligible for TTS with Section 475 ordinary income may have qualified business income (QBI), and the hedge fund is likely a specified service activity (SSA). If a non-active limited partner has taxable income under $315,000 (married) or $157,500 (other taxpayers), he or she might get a 20% deduction on the partnership share of QBI or taxable income less net capital gains (whichever is lower). In the $100,000/$50,000 phase-out range above the income threshold, the QBI deduction phase-out. Some investors may exceed the phase-out, and not qualify for the deduction, but others may have lower income and be eligible for the deduction.

A passive investor in a non-SSA might be eligible for the 20% deduction above the income threshold, subject to a 50% wage limitation, or alternative 25% wage limitation plus 2.5% of the qualified property. The 20% deduction on pass-through entities applies to active, non-active and passive owners without distinction. (Learn more about the 20% pass-through deduction on my blog post How Traders Can Get The 20% QBI Deduction Under New Law.)

Obamacare net investment tax retained
The new law retained the Obamacare net investment tax (NIT) of 3.8% on net investment income (NII) over modified AGI of $200,000 single and $250,000 married, not indexed for inflation.

The Act suspends investment expenses as a miscellaneous itemized deduction on Schedule A, but it does not interrupt investment expenses for NII. Form 8960 Part II “Investment Expenses Allocable to Investment Income and Modifications” includes miscellaneous investment expenses, investment interest expenses, and state, local and foreign income taxes. The new law capped state and local income taxes on Schedule A at $10,000 per year, but there is no cap for these expenses on Form 8960. Continue to keep track of these costs.

Ordinary tax rates reduced
The new law lowered tax rates on ordinary income for individuals for almost all tax brackets and filing status. It decreased the top rate to 37% in 2018 from 39.6% in 2017. Short-term capital gains are taxed at ordinary rates, so investors receive this benefit.

Repeal of the recharacterization option for Roth IRA conversions
If a 2017 converted Roth account drops significantly in value in 2018, a taxpayer can reverse the Roth conversion with a “recharacterization” by the due date of the tax return including extensions (Oct. 15, 2018). That’s the last year to do a reversal. The new law repeals this recharacterization option starting in 2018.

Temporary tax cuts for individuals
The individual tax cuts are temporary through 2025, which applies to most provisions, including the suspension of investment expenses. Republicans probably expect Democrats to extend, or make permanent, the individual tax cuts before the 2026 midterm election year. President Barrack Obama made the President George W. Bush’s 10-year tax cuts permanent for all individuals, other than the upper 2%, in the fiscal cliff at the end of 2012. In 2010, Obama extended all Bush tax cuts to 2012.

Republicans in Congress forged the new tax law in haste. A technical corrections bill is already in the works, and Republicans may need Democrats to pass it through regular order. There will be surprises from the IRS in their regulations and guidance, too. Tax planning is difficult until all these issues become settled.

Consider a consultation with Green Trader Tax to discuss the impact of the “Tax Cut And Jobs Act” on your investment activities.

Learn more about the new law and tax strategies for investors, traders and investment managers in Green’s 2018 Trader Tax Guide.


Traders Should Be Entitled To The Pass-Through Tax Deduction

December 20, 2017 | By: Robert A. Green, CPA


Congress passed the “Tax Cut and Jobs Act” (Act) on Dec. 20, and the President signed it into law on Dec. 22, 2017. The new law adopted the Senate Amendment for the 20% pass-through deduction, but it’s not clear how a trading company can use it. Traders should consider other smart moves as the Act suspended investment expenses, retained investment interest expense, and repealed NOL carrybacks.

Changes to pass through rules
The Conference Report (CR) decided on a 20% pass-through deduction vs. the Senate Amendment’s 23%. To meet the House halfway, the CR lowered the Senate’s taxable income (TI) threshold for “specified service activities” (SSA) to $157,500 single and $315,000 married. The CR retained the Senate phase-out range of $50,000 single and $100,000 married, above the TI threshold. For example, if an individual’s TI is over $207,500 single or $415,000 married, he or she won’t get any pass-through deduction on domestic “qualified business income” (QBI) in an SSA. But, individuals are entitled to a 20% deduction for QBI in a non-SSA at higher income levels, subject to the 50%-wage limitation above the threshold. (See examples in the Joint Explanatory Statement, p. 28-37.) The CR added an alternative wage limitation: 25% of wages plus 2.5% of “unadjusted basis, immediately after acquisition, of all qualified property,” which includes real estate and other tangible property. The House bill had a capital factor, which recognized investment in equipment.

I still have a few critical questions about the new law’s impact on TTS trading companies and TTS hedge funds.

1. Are TTS trading companies and TTS hedge funds an SSA?

In earlier posts, I thought a trading company was likely an SSA because “trading” is mentioned in the SSA definition.

The Joint Explanatory Statement definition of an SSA: “A specified service trade or business means any trade or business involving the performance of services in the fields of health, law, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners, or which involves the performance of services that consist of investing and investment management trading, or dealing in securities, partnership interests, or commodities. For this purpose a security and a commodity have the meanings provided in the rules for the mark-to-market accounting method for dealers in securities (sections 475(c)(2) and 475(e)(2), respectively).”

I wonder if the following part of the SSA definition applies to a hedge fund: “the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners.” A one-person TTS trading company does not market to investors, so they don’t have a reputation or brand intangible asset, and this part of the definition should not apply to them.

A management company provides the performance of investing, investment management and trading services to a hedge fund. The hedge fund is the customer in receipt of those services. A management company is a general partner of the hedge fund organized as a limited partnership, and the general partner can bring TTS to the hedge fund level. An outside manager would not suffice for the hedge fund achieving TTS.

The Act’s definition of SSA is a bit different, p. 33-34 states: ‘‘(2) SPECIFIED SERVICE TRADE OR BUSINESS.—The term ‘specified service trade or business’ means any trade or business— (A) which is described in section 1202(e)(3)(A) (applied without regard to the words ‘engineering, architecture,’) or which would be so described if the term ‘employees or owners’ were substituted for ‘employees’ there in, or (B) which involves the performance of services that consist of investing and investment management, trading, or dealing in securities (as defined in section 475(c)(2)), partnership interests, or commodities (as defined in section 475(e)(2)).”

The “specified service activity” term and definition stress the “performance of services” listing various types of service providers. A one-person TTS S-Corp trades for its account; it does not perform trading services for customers.

Even if a hedge fund is considered a non-SSA, an active or non-active owner is unlikely to achieve a 20% pass-through deduction due to the 50% wage limitation, or the alternative 25% wage limitation plus 2.5% of the unadjusted qualified property. Hedge funds don’t pay wages, and they don’t own significant qualified property. The management company pays compensation and has business equipment; not the hedge fund.

If the IRS considers a TTS S-Corp a non-SSA, there would likely be a 20% pass-through deduction above the SSA income threshold. The TTS S-Corp pays officer compensation of $146,000 to maximize a Solo 401(k) contribution of $55,000 (under age 50, 2018 limit). The 50% wage limitation would be $73,000 (50% of $146,000). $73,000 divided by the 20% deduction is net income of $365,000 in the TTS S-Corp. A spouse might also receive compensation. The Act requires a taxpayer to calculate QBI and the wage limitations on each interest in a pass-through entity, separately.

2. Can TTS trading income, including Section 475 ordinary income, be treated as “qualified business income” (QBI)?

The pass-through deduction formula is very complicated. In rough summary, it’s a 20% pass-through deduction calculated on the lower of combined QBI from domestic sources or taxable income less net capital gains. (See the Joint Explanatory Statement, p. 28-40.)

The QBI exclusion list does not mention Section 475 ordinary income, so it seems appropriate to include it in QBI. Only a TTS trader may elect Section 475. I covered this issue in my blog post Section 475 Traders May Be Eligible For Pass-Through Tax CutsSteven Rosenthal, Senior Fellow, Urban-Brookings Tax Policy Center, weighed in then, and I confirmed this with him again after enactment of the Act: “Section 475 treats the gain as ordinary income,” he says. “Section 64 provides that gain that is ordinary income shall not be treated as gain from the sale of a capital asset.” Mr. Rosenthal thinks Section 475 ordinary income is QBI under the Act for this reason and “because it’s not on the QBI exclusion list.”

QBI should also include ordinary income on a rental real estate activity. The media quoted several tax experts saying rental companies should benefit from the pass-through deduction, which means they consider rental income to be QBI. Those tax experts implied rental real estate companies are likely non-SSA and the 2.5% qualified property factor will lead to more active and passive owners being eligible for the 20% pass-through deduction.

If investors in the rental real estate activity can achieve the pass-through deduction on a non-SSA, then TTS traders with Section 475 should have non-SSA with QBI treatment, too. One company invests in real estate, the other in securities, and both have ordinary income. Neither entity performs services for clients.

The CR used the Senate Amendment’s definition of “Treatment of investment income” — the QBI exclusion list (full list included below). The Senate Amendment and CR deleted “short-term capital gains” (STCG) from (1), but left “long-term capital gains and losses.” Oddly, the Act itself left in STCG to (1). Rushing may have led to errors.

The CR states an exclusion of “investment-related” items.  A TTS trader or TTS hedge fund has “business-related” activity. I wonder if this could open the door to a TTS trader or TTS hedge fund having QBI on short-term capital gains that are business related. Perhaps, business-related Section 1256 capital gains with 60/40 rates should be included in QBI, too. There is a 60% long-term capital gain portion, but it’s not “long-term capital gains” that are “investment-related.”

The 20% deduction is on the lower of QBI or modified taxable income less net capital gains. For example, if a trader has QBI consisting of all business-related capital gains, and it’s his only TI, then he won’t get a deduction since modified TI less net capital gains might be zero. If the trader has significant other income, it could be different.

It’s much better for a TTS trader to elect Section 475 to have ordinary income: It’s safer to assume QBI includes Section 475 and that modified TI does not subtract Section 475 ordinary income.

See the definition (5) below. Forex trading is “directly related to the business needs of the business activity.” Some forex traders might want to retain Section 988 ordinary income treatment rather than file a contemporaneous capital gains election.

CR “Treatment of investment income: Qualified items do not include specified investment-related income, deductions, or loss. Specifically, qualified items of income, gain, deduction and loss do not include (1) any item taken into account in determining net long-term capital gain or net long-term capital loss, (2) dividends, income equivalent to a dividend, or payments in lieu of dividends, (3) interest income other than that which is properly allocable to a trade or business, (4) the excess of gain over loss from commodities transactions, other than those entered into in the normal course of the trade or business or with respect to stock in trade or property held primarily for sale to customers in the ordinary course of the trade or business, property used in the trade or business, or supplies regularly used or consumed in the trade or business, (5) the excess of foreign currency gains over foreign currency losses from section 988 transactions, other than transactions directly related to the business needs of the business activity, (6) net income from notional principal contracts, other than clearly identified hedging transactions that are treated as ordinary (i.e., not treated as capital assets), and (7) any amount received from an annuity that is not used in the trade or business of the business activity. Qualified items under this provision do not include any item of deduction or loss properly allocable to such income.” 

How to proceed
For 2018, trader tax status (TTS) traders should consider a partnership or S-Corp for business expenses, and a Section 475 election on securities for exemption from wash sale losses and ordinary loss treatment (tax loss insurance). Consider a TTS S-Corp for employee benefit plan deductions including health insurance and a high-deductible retirement plan, since a TTS spousal partnership or TTS sole proprietor cannot achieve employee benefit deductions. Consider this the cake. It puts you in position for potentially qualifying for a 20% QBI-deduction on Section 475 ordinary income in a TTS trading pass-through entity – icing on the cake. If a TTS trader’s taxable income is under the specified service activity (SSA) threshold of $315,000 married, and $157,500 other taxpayers, he or she might get the 20% QBI-deduction in partnerships or S-Corps. QBI includes Section 475 ordinary income, and it excludes capital gains. It might be a challenge for a TTS sole proprietor to claim the pass-through deduction, because Schedule C has trading expenses, only, and trading gains are on other tax forms. Trading in a C-Corp could be costly.

If you are interested in this 20% deduction for a trading or non-trading business, I suggest a  consultation with me soon.

How Businesses Can Save Taxes For 2017 Before Year-End

October 16, 2017 | By: Robert A. Green, CPA


The tax reform framework favors businesses by drastically cutting tax rates on corporations from 35% to 20% and pass-through entities from 39.6% to 25%. Pass-through entities (PTEs) include sole proprietorships, S-Corps, LLCs taxed as partnerships, general partnerships, and limited partnerships. These entities pass income and loss to the owner’s tax return. It’s wise for businesses to consider deferring income to take advantage of lower business tax rates in 2018 and accelerate business expenses to 2017. Even if Congress fails to pass tax reform, you’ll benefit from the time value of money.

Based on the tax reform framework, it’s uncertain if a trading business would be eligible for the lower PTE rate. There are nuances to consider for a trading business eligible for trader tax status (TTS) vs. a non-trading business. Officer compensation and employee benefit deductions work differently for S-Corps, partnerships, and C-Corps.

Officer compensation for a TTS trading business
I recommend an S-Corp structure for a TTS business to unlock employee benefit deductions including health insurance and retirement plans. You need to execute 2017 officer compensation with these deductions included before year-end, so don’t miss the boat!

W-2 wages should include health insurance premiums for 2% or more owners, which means the trader/owner and spouse if both provide services. (Attribution rules apply.) The health insurance premium component is not subject to payroll taxes. The S-Corp owner takes an AGI deduction for health insurance premiums on the individual tax return.

Some traders use a dual entity structure: A trading partnership and separate management company organized as a C-Corp or S-Corp. The management company should execute year-end payroll and health insurance deductions. A C-Corp management company may deduct health insurance premiums and health reimbursement accounts directly on the corporate tax return and don’t include it in payroll like the S-Corp. The trading partnership should pay administration fees to the management company before year-end.

Officer compensation for a non-trading business
The IRS requires S-Corps with underlying earned income (i.e., investment advisory fees or consulting fees) to have “reasonable compensation.” Current industry practice is 25% to 50% of net income before officer compensation. The IRS does not require a trading S-Corp to have reasonable compensation because it has underlying unearned income. However, the IRS does look for officer compensation on all S-Corp tax returns.

An LLC with earned income filing a partnership return or general partnership should use “guaranteed payments” for officer compensation. A partnership tax return with underlying earned income may arrange health insurance and retirement plan deductions in a similar manner to S-Corps. The IRS does not permit an investment company, not eligible for TTS, to have guaranteed payments and employee benefit deductions.

If the S-Corp, TTS or non-trading business, is profitable, consider a Solo 401(k) retirement plan contribution. Execute the 100% deductible elective deferral portion through officer compensation in payroll. This wage component is subject to payroll taxes.

Establish a high-deductible retirement plan
Eligible trading businesses and other businesses should consider a Solo 401(k) retirement plan. For 2017, S-Corp officer wages of $144,000 unlock the maximum $54,000 contribution/deduction or $60,000 if age 50 or older with the $6,000 catch-up provision. The 100%-deductible elective deferral up to $18,000, or $24,000 with the catch-up provision, provides the greatest income tax savings vs. payroll tax costs. You can set wages to cover the elective deferral amount, which limits payroll taxes. The 25%-deductible profit-sharing plan up to $36,000 is good if you have sufficient cash flow to invest in tax-free compounded growth within the plan.

Businesses that achieve consistently high income can arrange a $100,000+ contribution/deduction with a defined-benefit plan (DBP) if the owners are close to age 50. Business owners should work with an actuary on complex DBP calculations.

Solo 401(k) and defined benefit plans must be established before year-end, but you can do most of the funding in the new year. Setting up a DBP can take several weeks, so get started by early December.

Continue qualification for trader tax status
Traders should maintain eligibility for TTS as long as possible, whether as a sole proprietor, S-Corp, or partnership. If you formed a trading S-Corp mid-year 2017, it helps deflect potential IRS challenges if you continue into 2018.

Convert a 2017 wash sale loss into a 2018 ordinary loss
If you have wash sale loss deferrals at year-end on trading positions in your account, claim sole proprietor TTS for 2017 and 2018 if possible. A Section 475 election for 2018 will convert the wash sale loss deferral on TTS positions into an ordinary loss on Jan. 1, 2018. That’s much better than a capital loss in 2018.

The IRS said it might change the effective date of a Section 475 MTM election to “freeze and mark” the day it’s elected, rather than taking effect retroactively on Jan. 1. The IRS also said it might change the character of Section 481(a) adjustment (required for a Section 475 election) to capital gains and losses, rather than ordinary income or loss.

Accounting methods
Businesses may select an accounting method for recognizing the timing of revenues and expenses. Most small businesses choose the cash method, which reports revenues when collected and expenses when paid. It’s a more straightforward accounting system, providing flexibility in tax planning. Companies with inventory may or must use the accrual method, which records revenue when earned and expenses when incurred. Cash method taxpayers can defer gross revenues and accelerate expenses more easily than accrual method taxpayers.

Employees should talk to their employers about deferring their bonus to 2018. If you own a small business, consider postponing completion of client engagements and invoice them in 2018. Cash method taxpayers can hold off on collection efforts until 2018.

Be aware of the “constructive receipt of income” rules: If you receive income for services, you have to report it. (You cannot put a check in a drawer and report it later!) If a customer attempts to pay you for services and you decline receipt, it may be constructive receipt of income.

Maximize tangible property expenses (TPE)
Businesses can expense new tangible property items up to $2,500 per item, a great way to defer income. Purchase and begin using TPE items before year-end. Arrange separate invoices for each item not exceeding $2,500 and be sure to make the de minimis safe harbor election with your tax return filing.

Section 179 (100%) depreciation
For equipment, furniture and fixtures above the tangible property threshold ($2,500), use Section 179 depreciation allowing 100% depreciation expense in the first year. The Protecting Americans From Tax Hikes (PATH) Act of 2015 made permanent generous Section 179 limits. The 2017 limit is $510,000 on new and used equipment including off-the-shelf computer software. Buildings do not qualify for this deduction. The IRS limits the use of Section 179 depreciation by requiring income to offset the deduction. Look to business trading gains, other business income or wages, from either spouse, if filing jointly.

Additions and improvements to office
Consider an addition or improvements to your home office like constructing more space, replacing windows, walls, and flooring. Depreciate residential real property over 39 years on a straight-line basis. If you rent or own an outside office, depreciation rules are more attractive. PATH created “qualified improvement property” — a new class of nonresidential real property, excluding additions like increasing square footage. Use 50% bonus depreciation on qualified improvement property placed in service in 2017. PATH extended bonus depreciation through 2019.

Home office expenses
“Use or lose” an S-Corp accountable plan before year-end for reimbursing business expenses paid individually, including home office expenses. LLC Operating Agreements and partnership agreements may provide that partners should deduct home office expenses as “unreimbursed partnership expenses” (UPE) on their individual tax returns.

Capitalize expenses for a new business
If you plan to become eligible for TTS or another type of business in early 2018, consider capitalizing late-year 2017 purchases for business expense deductions in 2018. I suggest this strategy for Section 195 start-up costs including training and mentors, Section 248 organization costs for a new entity, and internal-use software including automated trading systems. Otherwise, you might not get any tax deduction for these items in 2017. (Learn more about these deductions in my blog post Top 10 Tax Deductions For Active Traders.)

Maximize net operating losses
If you have an NOL generated in 2017, try to enhance it as much as possible and consider the two-year NOL carryback option — an excellent way to achieve quick tax refunds. Earlier tax blueprints discussed repealing NOL carrybacks and retaining the 20-year NOL carry forward.

Avoid passive-activity losses on pass-through entities
Consider selling some passive loss activities to convert suspended tax losses carried over from prior years into realized losses in the current year. Alternatively, you could spend more time on the business to meet material participation requirements, which generate non-passive losses. Passive-activity entity income or loss is part of net investment income (NII) for calculating the 3.8% net investment tax, which applies to upper-income taxpayers (modified AGI of $200,000 single, $250,000 married, and not indexed for inflation).

Shifting income to family members with gifts and wages
The 2017 annual gift tax exclusion is $14,000 per person, per donor. The current tax reform framework repeals the federal estate tax starting in 2018, so the “unified credit” against the estate tax may become moot. The unified credit is reduced by annual gift amounts made over the gift tax exclusion. Twenty states currently have estate or inheritance taxes.

Shifting income to family members can be a smart strategy. Be aware of the “kiddie tax” rules, which limit the benefit of moving too much investment income to young children, including qualifying young-adult children.

Paying wages for teenage and adult children is an efficient way to avoid the kiddie tax rules, which apply to unearned income. According to, “Payments for the services of a child under age 18 who works for his or her parent in a trade or business are not subject to social security and Medicare taxes if the trade or business is a sole proprietorship or a partnership in which each partner is a parent of the child.” Also, you will save federal and state unemployment insurance and state workmen’s compensation on children under age 21.

Manage debt cancellation income (DCI) properly
DCI is excludable from gross income providing the debtor is insolvent or filed for bankruptcy. If you are not insolvent or bankrupt, try to defer DCI taxable income to 2018.

Stay tuned for tax reform developments
Wait for final tax legislation expected in November 2017 to see how the anti-abuse measures work on preventing wealthy business owners from recharacterizing their individual (personal) income as business income to qualify for lower PTE rates up to 25% vs. the top ordinary rate of 35%. Will tax reform allow a trading company, perhaps with Section 475 ordinary income, to use the lower business tax rate of 25% on pass-through entities? Will employee benefit plan deductions for health insurance and retirement plans continue? (Stay tuned on our blog and see How Tax Reform Framework Impacts Traders And Investors.)

See my last blog post How Individuals Can Save Taxes For 2017 Before Year-End.

If you have any questions on tax planning, contact your tax advisor for help. I’m encouraging our clients to sign up for our tax compliance service soon to begin year-end tax planning before Dec. 5, 2017.

Attend our Webinar or watch the recording after: How To Save Taxes For 2017 Before Year-End.

How Individuals Can Save Taxes For 2017 Before Year-End

October 14, 2017 | By: Robert A. Green, CPA



How Individuals Can Save On 2017 Taxes Before The End Of The Year.

October through December is an excellent time to consider year-end tax planning moves to save taxes for 2017. Once tax season gets underway in Q1 2018, it’s too late for these smart ideas.

As tax reform advances through Congress, it’s safe to assume your tax rates may be lower in 2018 and some of your expenses will likely be repealed to pay for tax rate cuts. It’s probably wise to use the time-honored strategy of deferring income and accelerating payments to deduct them while you can. Even if Congress fails to pass tax reform, you’ll benefit from the time value of money.

Repealing most itemized deductions
In exchange for lowering corporate tax rates, the tax reform framework repeals most itemized deductions for individuals starting in 2018. The two notable exceptions are deductions for mortgage interest expenses and charitable contributions. Tax reform compensates for middle-income folks by doubling the standard deduction. You should try to pay all 2017 expenditures before year-end to get the deduction while you can and reduce 2017 income.

The tax reform framework repeals “miscellaneous itemized deductions,” which include investment expenses, tax compliance fees and unreimbursed employee business expenses deducted on Form 2106. You should try to pay service providers for 2017 services by year-end. Traders who are eligible for trader tax status (TTS) have business expense treatment, bypassing miscellaneous itemized deductions.

Investment advisory fees, including management fees and incentive fees, are investment expenses, which face repeal in 2018. Brokerage commissions are not investment expenses. Transaction costs are adjustments to proceeds and cost basis, reflected in capital gains and losses. The current framework was silent about earlier blueprints to repeal carried-interest tax breaks for hedge fund managers. I expect these changes would impact the investment management industry, which may consider changes to business models to achieve better tax efficiency.

Employees should submit expenses to employers for reimbursement before year-end since accountable plans have “use it or lose it” rules. Under current law, miscellaneous itemized deductions are deductible above a 2% AGI threshold, and they are not deductible for AMT. If your employer doesn’t have an accountable plan, encourage them to consider one for 2017 and 2018.

Accelerate state and local tax deductions
The current tax reform framework repeals itemized deductions for state and local taxes including income, real estate, property and sales and use taxes. States without an individual income tax, including Texas, Florida, and Washington, have real estate and sales and use taxes. For 2017, you can elect to claim sales and use taxes as an itemized deduction instead of state income taxes. If you are thinking about buying an expensive item that is subject to sales and use tax, consider purchasing it before year-end. Accountants are looking into ways for a business to treat some state and local taxes as a business expense.

The tax reform framework repeals state and local tax deductions and AMT starting in 2018, so your best chance at a deduction might be to pay state and local taxes due by Dec. 31, 2017. This is a change from previous tax years when individuals may have postponed state and local taxes to avoid AMT. Be sure to check the latest developments on tax reform before you make this decision close to Dec. 31 since there is blowback on the repeal of state and local taxes, and I expect there could be changes.

Casualty loss deductions
The tax reform framework repeals the casualty loss itemized deduction for 2018, so try to complete your claims to support a 2017 tax deduction. The 2017 disaster tax relief bill for Hurricanes Harvey, Irma and Maria victims exempts qualified disaster-related personal casualty losses from the 10% AGI threshold. Victims don’t have to itemize; they can add this casualty loss to their standard deduction, and that part is deductible for AMT. (Hopefully, Congress applies this same relief to victims of the California wildfires.)

Maximize charitable contributions
You should make tax-deductible donations before year-end by check and credit card. Property donations of clothing, household goods, and appreciated securities can also be deducted. The itemized deduction is calculated based on fair market value (FMV), or another acceptable method. The FMV of clothing and household goods is usually a small fraction of the purchase price. When you deduct the FMV of appreciated securities, you avoid capital gains taxes. For charitable donations over $250, the IRS requires a written acknowledgment letter. Expect a reduction of the contribution amount based on the value of goods and services you receive, for example at a charity dinner.

The IRS permits individuals age 70½ or older to make charitable gifts up to $100,000 per person, per year, directly from their IRAs, and this generates several tax benefits. The strategy is more tax efficient than taking an income distribution and potentially losing some of the deduction with the Pease itemized deduction limitation for upper-income taxpayers or using the standard deduction. Avoiding an IRA withdrawal lowers AGI, which may unlock middle-income deductions and credits and avert net investment tax (NIT). The charitable donation amount also counts toward meeting the required minimum distribution (RMD) rule. You may not receive goods and services in connection with this donation from the IRA, other than an intangible religious benefit.

Other itemized-deduction limitations
Upper-income individuals should be aware of the 2017 Pease itemized deduction limitation, indexed for inflation: $261,500 single and $313,800 married filing joint for 2017. It wipes away many of your itemized deductions.

The AGI percentage threshold for medical expenses is 10%, and for miscellaneous itemized deductions it’s 2%. Investment interest expenses are limited to investment income, and an investment interest carryover likely won’t be beneficial in 2018 since tax reform repeals it.

Capital gains and net investment tax
The tax reform framework omitted capital gains tax cuts. Previous blueprints applied lower long-term capital gains rates to all capital gains, dividends and interest income, but I expect the current law to continue.

Many investors hoped Republicans would repeal the Obamacare 3.8% net investment tax (NIT) on unearned income, but they retained NIT in the healthcare bills and tax reform framework. Consider reducing income under the thresholds for triggering NIT (modified AGI of $200,000 single, $250,000 married, and not indexed for inflation), or defer net investment income to 2018. The repeal of investment expenses in 2018 will likely also repeal them as a deduction from net investment income (NII), used to calculate NIT.

Tax loss selling
A taxpayer with capital gains can reduce taxes by selling losing securities positions, realizing capital losses, before year-end. This continues to be a smart strategy in 2017, however, if you already have a $3,000 capital loss limitation, tax loss selling won’t help.

Wash sale loss adjustments
Be careful not to trigger a wash sale loss adjustment at year-end by buying back a substantially identical position 30 days before or after realizing a tax loss on a security. In a taxable account, a wash sale loss adjustment from December is deferred to January, adding the tax loss to the replacement position’s cost basis. It accelerates income, when your plan may be to delay income. Congress doesn’t want taxpayers to realize “tax losses” that are not “economic losses.”

If you realize a tax loss in an individual taxable account and buy back a substantially identical position in a traditional IRA or Roth IRA, you will never get the benefit of that tax loss. Avoid this catastrophic problem with “Do Not Trade Lists” between your IRA and taxable accounts.

In taxable accounts, avoid wash-sale loss adjustments at year-end by “breaking the chain.” Sell open positions and don’t get back into substantially identical positions for 30 days before and after selling them. For example, sell the entire position on Dec. 15 and don’t repurchase it until Jan. 16. In December, use trade accounting software to identify potential wash sale loss adjustments so you can break the chain before year-end.

Don’t solely look at a broker’s tax report or 1099-B for identifying potential wash sale losses. The IRS requires taxpayers to assess wash sales across all brokerage accounts, whereas, brokers only look at a single brokerage account. Brokers calculate wash sales based on an exact symbol (identical position), whereas, taxpayers must base wash sales on “substantially identical positions,” an equity and its equity options, at different expiration dates. Many active securities traders are surprised with big tax bills on April 15 because they mishandled wash sale losses at year-end.

Mark-to-market accounting
Section 1256 contracts, which include futures and broad-based indexes, and Section 475 trades for traders with trader tax status (TTS), are both mark-to-market (MTM) code sections. MTM imputes sales of open positions at year-end, so you are reporting realized and unrealized gains and losses. That negates the need to do tax loss selling. MTM comes with Section 1256 by default, and Section 1256 is capital gain and loss treatment.

Individual TTS traders had to elect Section 475 ordinary gain or loss treatment for 2017 by April 18, 2017, or have elected it in a prior year. Existing partnerships and S-Corps had to elect it by March 15, 2017. The next opportunity to file a Section 475 election is for 2018, or within 75 days of inception for a new entity. I call Section 475 “tax loss insurance” because it exempts traders from the capital loss limitation and wash sale loss adjustments.

Try to be eligible for middle-income tax benefits
Each of these tax breaks has different AGI phase-out ranges. Try to reduce your 2017 AGI to maximize deductions for education, and student loan interest, increase child care credits and the personal exemptions and lower AMT and NIT taxes. You may need to prepare a draft tax return to see where you stand on all these moving parts.

Avoid the highest individual ordinary tax rate
Upper-income individuals should try to avoid the top tax bracket of 39.6%, which starts at taxable income of $418,400 for single filers and $470,700 for married filers. The second bracket is 35%, which the tax reform framework uses as its top bracket for 2018. The tax reform framework empowered Congress to add back a higher top bracket for 2018 to ensure tax reform is progressive. Tax writers have not yet committed to the bracket income ranges, which could make all the difference.

Maximize use of the 0% long-term capital gains brackets
Long-term capital gain rate brackets correlate with ordinary rates for 2017. The 20% capital gains rate applies in the 39.6% ordinary-income tax bracket. The 15% capital gains rate applies to ordinary rates over 15% and under 39.6%. The 0% capital gains rate applies for the 10% and 15% ordinary brackets. If you are in the 10% and 15% ordinary tax brackets, try to sell long-term capital gains before year-end to take advantage of zero capital gains taxes. (State taxes may apply.)

There’s a long-term capital gains rate component in Section 1256 contracts: 60% long-term capital gains and 40% short-term capital gains. The blended 60/40 capital gains rate for the 10% bracket is 4%, and for the 15% bracket, it’s 6%. There is no sense in postponing income if you can pay such a low tax rate.

Arrange required minimum distributions
Take RMDs from traditional IRA, Solo 401(k) plan, and employer retirement plans. Commence RMDs by April 1 of the year following the calendar year in which you reach age 70½. Per, “If you do not take any distributions, or if the distributions are not large enough, you may have to pay a 50% excise tax on the amount not distributed as required.”

Avoid estimated tax underpayment penalties
Many traders and small business owners don’t pay quarterly estimated taxes in Q1, Q2, and Q3 since they might lose significant money in Q4, so strategies to avoid underpayment penalties are helpful. Consider increasing federal and state tax withholding on paychecks before year-end as the IRS and states treat W-2 tax withholding as being made throughout the year.

Fully fund health plans
If you have a health savings account, be sure to pay the maximum allowed contribution for 2017 before year-end. (Self-only is $3,400, family coverage is $6,750, and $1,000 catch-up contributions are allowed for age 55 or older.) Increase your employer’s health flexible spending account for 2018 if you had too little funding in 2017.

Income acceleration strategy
If you’re in a low tax bracket for 2017 and expect to be in a higher tax bracket for subsequent years, including retirement years, consider a Roth IRA conversion before year-end 2017.

This is often a wise move since Roth IRAs are permanently tax-free, whereas traditional IRAs are only temporarily tax-free. Be careful not to take early withdrawals from any of your Roth IRAs for at least five years, and before you reach age 59½, otherwise you may trigger taxation on nonqualified distributions. Roth IRAs are not subject to RMD rules, which apply to traditional IRAs and qualified plans. If the Roth IRA account substantially drops in value after the conversion date, you can reverse the conversion by Oct. 15, 2018.

In my next post, I cover year-end tax planning for businesses, including traders with trader tax status: How Businesses Can Save Taxes For 2017 Before Year-End.

If you have any questions on tax planning, contact your tax advisor for help. I’m encouraging our clients to sign up for our tax compliance service soon to begin year-end tax planning before Dec. 5, 2017.

Darren Neuschwander CPA contributed to this blog post.

Attend our Webinar or watch the recording after: How To Save Taxes For 2017 Before Year-End.