Category: Tax Compliance

Tips For Traders On Preparing 2023 Tax Returns

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

See IRS Form 8995 and 8995-A.

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

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

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

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

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

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

Please take a look at Section 1256 Contracts.

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

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

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

For more information, see Cryptocurrencies.

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

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

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

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

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

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

See Wash Sale Losses.

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

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

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

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

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

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

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

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

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

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

Common errors

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

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

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

Some traders use TTS and 475 when they should not.

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

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

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

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

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

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

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

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

Tax extensions

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

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

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

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

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

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

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

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

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

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

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

See Tax Extensions: 12 Tips To Save You Money.

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


Traders Should Focus On Q4 Estimated Taxes Due January 16

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

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

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

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

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

Suppose your 2022 tax liability was $40,000 and your AGI was over $150,000. Assume 2023 taxes will be approximately $100,000, and you haven’t paid estimates going into Q4. Using the safe-harbor rule, you can spread out the payment, submitting $44,000 (110% of $40,000) with a Q4 voucher on January 16, 2024, and paying the balance of $56,000 by April 15, 2024. This is a good option when compared to sending $90,000 in Q4 (90% of $100,000). Consider setting aside that tax money due on April 15, 2024, rather than risking it in the financial markets in Q1 2024. I’ve seen some traders lose the money they planned to use to pay taxes by trading it in the market. No money to pay your taxes causes trouble with the IRS. (See the example below.)

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

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

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

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

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

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

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

Star Johnson, CPA, contributed to this blog post.

 

 


Tax Planning For Traders

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

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

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

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

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

EXCESS BUSINESS LOSSES AND NET OPERATING LOSSES

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

DEFER INCOME AND ACCELERATE TAX DEDUCTIONS

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

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

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

ACCELERATE INCOME AND DEFER CERTAIN DEDUCTIONS

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

ROTH IRA CONVERSION

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

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

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

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

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

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

NET INVESTMENT INCOME TAX

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

BUSINESS EXPENSES AND ITEMIZED DEDUCTION VS. STANDARD DEDUCTION

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

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

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

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

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

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

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

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

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

ESTIMATED INCOME TAXES

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

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

See Interest rates increase for the fourth quarter 2023. 

ADJUST WITHHOLDING ON YEAR-END PAYCHECKS

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

AVOID YEAR-END WASH SALE LOSS ADJUSTMENTS

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

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

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

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

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

TRADER TAX STATUS AND SECTION 475

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

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

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

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

20% DEDUCTION ON QUALIFIED BUSINESS INCOME

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

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

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

SUSPENDING TTS AND SECTION 475

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

TAX-LOSS HARVESTING

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

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

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

TAX EFFICIENT SALES

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

STRADDLES AND THE CONSTRUCTIVE SALE RULES

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

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

CHARITABLE CONTRIBUTIONS

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

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

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

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

TAX RELIEF: PRESIDENTIALLY DECLARED DISASTER AREAS

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


Highlights From Green’s 2023 Trader Tax Guide

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

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

BUSINESS TRADERS FARE BETTER

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

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

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

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

CAN TRADERS DEDUCT TRADING LOSSES?

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

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

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

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

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

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

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

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

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

WASH-SALE LOSSES

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

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

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

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

EXCESS BUSINESS LOSS LIMITATION

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

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

See more about EBL and its thresholds in Chapter 2.

TAX TREATMENT ON FINANCIAL PRODUCTS

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

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

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

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

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

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

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

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

ENTITIES FOR TRADERS

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

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

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

RETIREMENT PLANS FOR TRADERS

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

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

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

DEDUCTION ON QUALIFIED BUSINESS INCOME

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

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

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

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

For more information, see Chapter 7 and Chapter 17.

SALT CAP WORKAROUND

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

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

DESK REFERENCE

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

Table of Contents

Highlights. 

Chapter 1  Trader Tax Status.

Chapter 2  Section 475 MTM Accounting. 

Chapter 3   Tax Treatment of Financial Products. 

Chapter 4  Accounting for Trading Gains & Losses. 

Chapter 5   Trading Business Expenses.

Chapter 6  Trader Tax Return Reporting Strategies.

Chapter 7  Entity Solutions. 

Chapter 8  Retirement Plans.

Chapter 9  Tax Planning.

Chapter 10  Dealing with the IRS and States.

Chapter 11  Traders in Tax Court.

Chapter 12  Proprietary Trading. 

Chapter 13   Investment Management.

Chapter 14   International Tax. 

Chapter 15  ACA Net Investment Income Tax. 

Chapter 16   Short Selling. 

Chapter 17  Tax Cuts and Jobs Act.

Chapter 18  CARES Act.

 


Tax Extensions: 12 Tips To Save You Money

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

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

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

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

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

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

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

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

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

Check these types of penalties with your state, too. 

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

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

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

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

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

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

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

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

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

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

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

Tip 7: Be conservative with tax payments
I’ve always advised clients to be aggressive but legal with tax-return filings and look conservative with cash (tax money). Impress the IRS with your patience on overpayment credits and demonstrate you’re not hungry and perhaps overly aggressive to generate tax refunds. It’s wise for traders to apply overpayment credits toward estimated taxes owed on current-year trading income. You want to look like you will be successful in the current tax year.

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

Tip 8: Get more time to fund qualified retirement plans
The extension also pushes back the deadline for paying money into qualified retirement plans, including a Solo 401(k), SEP IRA, and defined benefit plan. The deadline for 2023 IRA contributions is April 18, 2023.

Tip 9: Respect the policies of your accountants
Your accountant can prepare extension forms quickly for a nominal additional cost related to that job. There are no fees from the IRS or state for filing extensions. Be sure to give your accountant the tax information received and estimates for missing data.

Your accountant begins your tax compliance (preparation) engagement, and they cut it off when seeing a solid draft to use for extension filing purposes. Your accountant will wait for the final tax information to arrive after April 18, 2023. Think of the extension as a half-time break. It’s not procrastination; accountants want tax returns finished.

Please don’t overwhelm your tax preparer the last few weeks and days before April 18 with minor details in a rush to file a complete tax return. Accounting firms with high-quality standards have internal deadlines for receiving tax information for completing tax returns. It’s unwise to pressure your accountant, which could lead to mistakes or oversights in a rush to file a complete return at the last minute. That doesn’t serve anyone well.

Tip 10: Securities traders should focus on trade accounting
It doesn’t matter if your capital loss is $50,000 or $75,000 at extension time: Either way, you’ll be reporting a capital loss limitation of $3,000 against other income. In this case, don’t get bogged down with trade accounting and reconciliation with Form 1099Bs until after April 18. The capital loss carryover impacts your decision to elect Section 475 MTM for 2023 by April 18, 2023, but an estimate is sufficient.

Consider wash-sale loss rules on securities: If these adjustments don’t change your $3,000 capital loss limitation, you can proceed with your extension filing. But if you suspect wash-sale loss adjustments could lead to reporting capital gains rather than losses, or if you aren’t sure of your capital gains amount, focus your efforts on trade accounting before April 18. (Consider TradeLog or GNM’s trade accounting service.) Try to do accounting work for year-to-date 2023; it also affects your decision-making on the 475 election.

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

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

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

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

Darren Neuschwander, CPA, contributed to this blog post. 

 

 


Tax Relief In Disaster Situations

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

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

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

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

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

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

Affected taxpayers

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

All counties in California are listed as affected counties except:

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

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

Returns

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

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

Payments

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

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

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

The IRS press releases are available at:

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

California press releases are available at:

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

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

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

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


Tax Tips For Traders Preparing 2022 Tax Returns

February 15, 2023 | By: Robert A. Green, CPA | Read it on

Trader tax status (TTS) is the ticket to tax savings. If you qualify, you can claim some tax breaks, such as business expenses, after the fact and elect and set up other tax breaks — like Section 475 MTM accounting (tax loss insurance) and health insurance and retirement plan deductions through an S-Corp— on a timely basis. 

TTS vs. Section 475 MTM accounting
If you qualified for TTS in 2022, you could claim business expenses on Schedule C. No IRS election was required. Don’t confuse that with a Section 475 MTM accounting election that a TTS trader could have submitted by April 18, 2022, for the tax year 2022.

The 475 election is like applying to graduate school, and TTS is like graduating from an undergraduate university; you need TTS to make and use a 475 election. It’s not too late to use TTS business expenses on your 2022 tax return, but it is too late to use Section 475 MTM to avoid wash sale losses if you missed the 475 election.

How to qualify for TTS

  • Volume: We recommend an average of four transactions per day, four days per week, 16 trades per week, 60 a month, and 720 per year on an annualized basis. Count each open and closing transaction separately, not round trip. Scaling in and out counts, too.
  • Frequency: Execute trades on nearly four weekly days, around a 75% frequency rate.
  • Holding period: The IRS said the average holding period must be 31 days or less. That’s a bright-line test.
  • Trades full-time or part-time for a good portion of the day; the markets are open almost daily. Part-time and money-losing traders face more IRS scrutiny, and individuals face more scrutiny than entity traders.
  • Hours: Spends more than four hours daily, almost every market day, working on their trading business — all-time counts.
  • Avoid sporadic lapses: A trader has few to no intermittent stoppages in the trading business during the year. Vacations are okay.
  • Intention: Has the intention to run a business and make a living. It doesn’t have to be your primary living.
  • Operations: Has significant business equipment, education, business services, and a home office.
  • Account size: Securities traders need to have $25,000 on deposit with a U.S.-based broker to achieve “pattern day trader” (PDT) status. For the minimum account size, we like to see more than $15,000.

Tax reporting for a sole proprietor trading business

Multiple tax forms
The IRS uses multiple tax forms for trading businesses eligible for TTS. It can be confusing to taxpayers, accountants, and the IRS. Traders enter gains and losses, portfolio income, and business expenses in various tax forms.

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

Schedules C for expenses only
Most sole-proprietorship businesses report revenue, cost of goods sold, and expenses on Schedule C. The IRS can easily see if they are profitable; they cannot do so with sole proprietor traders.

TTS traders qualifying for TTS report only trading business expenses on Schedule C. Trading gains and losses are reported in other tax forms, depending on the situation. If possible, it’s helpful to include a tax return footnote tying the trader schedules together in your tax compliance software to show profitability. Entity tax returns do that.

Schedule D and Form 8949
Sales of securities for each trade (no summary reporting) are reported on Form 8949, which feeds into Schedule D (cash method) with net capital losses limited to $3,000 per year against ordinary income (the rest is a capital loss carryover). Capital losses are unlimited against capital gains.

See IRS instructions for Form 8949 and Form 8949 for 2022 taxes: “Note: You may aggregate all short-term transactions reported on Form(s) 1099-B showing basis was reported to the IRS and for which no adjustments or codes are required. Enter the totals directly on Schedule D, line 1a; you aren’t required to report these transactions on Form 8949 (see instructions).” Most traders have WS loss adjustments, so they must report each trade on Form 8949.

See Securities and Form 8949 & 1099-B Issues. Cost-basis reporting has complicated tax compliance, and traders use trade accounting software for help.

Schedule 4797 for MTM accounting
TTS traders who elected and used Section 475 MTM on securities report each securities trade on Form 4797 Part II. MTM means open securities trades are marked-to-market at year-end prices. Traders still report sales of segregated investments in securities (without MTM) on Form 8949 and Schedule D.

Form 4797 Part II receives ordinary gain or loss treatment avoiding the capital loss limitation and wash-sale loss rules. (It’s “tax loss insurance.”) Profitable traders also can benefit from Section 475 using the qualified business income (QBI) deduction.

Section 475 Election
Existing taxpayers file a Section 475 election statement by the due date of the prior year’s tax return or extension with the IRS and perfect it later with a Form 3115 (change in accounting method) filing by the tax return deadline, including extension. Learn about making a Section 481(a) adjustment to convert from the realization to the MTM method of accounting.

A Section 475 election for 2022 was due by April 18, 2022. The next opportunity to elect 475 is for 2023, by April 18, 2023. Learn the nuances of making a 475 election here.

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

Excess business losses and net operating losses
The net Section 475 losses and TTS business expenses are subject to the excess business loss (EBL) limitation for the tax year 2022. You can aggregate EBL from all pass-through businesses. The inflation-adjusted 2022 EBL threshold is 540,000 (married)/$270,000 (other taxpayers). For 2023, the amount is $578,000 (married)/$289,000 (other taxpayers). The amount over the EBL threshold is a net operating loss (NOL) carry forward.

TCJA repealed net operating loss (NOL) carrybacks (except for farmers) and limited NOL carryforwards to 80% of the subsequent year’s taxable income.

 

Qualified business income (QBI) deduction
There’s also a tax benefit on net Section 475 gains: the 20% QBI deduction. In a simple scenario, on a QBI of $100,000, the owner can deduct $20,000. That’s a tax deduction without spending any money.

Trading is a “specified service trade or business” (SSTB), which means an income cap applies. If your taxable income is over that cap, there is no QBI deduction. QBI includes Section 475 ordinary income, less TTS expenses, and excludes capital gains, portfolio income, and forex trading income. See the QBI income cap and phase-out range in Green’s 2023 Trader Tax Guide.

Schedule 6781 for futures
Section 1256 contract traders (i.e., futures) should use Form 6781 (unless they elected Section 475 for commodities/futures; those are reported on Form 4797). Section 1256 traders don’t use Form 8949 — they rely on a one-page Form 1099-B showing their net trading gain or loss (aggregate profit or loss on contracts). That amount is entered in summary format on Form 6781 Part I.

Section 1256 contracts enjoy lower 60/40 capital gains tax rates: 60% (including day trades) subject to lower long-term capital gains rates and 40% taxed as short-term capital gains using the ordinary rate. At the maximum tax bracket for 2022, the blended 60/40 rate is 26.8% — 10.2%, lower than the highest regular bracket of 37%.

Most futures traders skip a Section 475 election to retain 60/40 capital gains rates. See Section 1256 Contracts.

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

Cryptocurrencies
For sales of cryptocurrencies, use Form 8949, but not wash sales or Section 475 MTM. See Cryptocurrencies

The IRS updated its question about digital assets on the 2022 Form 1040. Instead of asking about “virtual currency,” for 2022, the question asks: “At any time during 2022, did you: (a) receive (as a reward, award or payment for property or services); or (b) sell, exchange, gift or otherwise dispose of a digital asset (or a financial interest in a digital asset)?” (IR 2023-12, 1/24/2023).

Cryptocurrencies: recent bankruptcies: The IRS is considering issuing broader guidance and tax relief for crypto investors if the crypto is no longer traded on an exchange or the taxpayer is locked out of accessing the currency due to bankruptcy.” See Chief Counsel Memorandum (Number 202302011) and Crypto Investors Facing Losses Could Get IRS Guidance to Help (Bloomberg Law Feb. 10, 2023)

Tax treatment for financial products
We cover U.S. and international equities, U.S. futures, and other Section 1256 contracts, options, ETFs, ETNs, forex, precious metals, foreign futures, cryptocurrencies, and swap contracts.

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

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

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

Buying back a losing December 2022 trade within 30 days into January 2023 triggers a 2022 WS loss added to the WS column on the 2022 Form 1099-B. The 2022 WS loss amount is removed from the 2022 cost basis column and is deferred to the 2023 cost basis. That reduces a December 2022 capital loss. Our blog post, How To avoid Phantom Income From Wash Sale Loss.

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

Please take a look at 1099-B and the instructions.

Some brokers provide a Form 8949 worksheet, which can be imported into TurboTax.

Trade accounting using TradeLog
We had recommended TradeLog (TL) every year since 2001, when we helped bring Section 475 MTM accounting to the program. Use TL to download your trade history from your broker’s Website (not the 1099-B) and calculate WS according to IRS rules for taxpayers. TradeLog can also calculate WS according to IRS rules for brokers, which should match broker 1099-Bs. TL generates Form 8949 or Form 4797 (for Section 475 MTM).

You can license the TL software to do the trade accounting. Alternatively, TL can do this trade accounting for you as a service. Green, Neuschwander & Manning, LLC (GNM) offers trade accounting services using TradeLog to clients of GNM’s tax compliance service.

Business expenses if qualified for TTS

  • Tangible personal property like a computer, up to $2,500 per item.
  • Section 179 (100%), bonus, and regular depreciation on computers, equipment, furniture, and fixtures.
  • Amortization of start-up costs (Section 195), organization costs (Section 248), and software.
  • Education expenses paid and courses taken after the commencement of the trading business activity. (Otherwise, pre-business education may not be deductible or included a portion in Section 195 start-up costs.)
  • Trader business expenses
  • Books, publications, subscriptions, market data, online and professional services, chat rooms, mentors, coaches, supplies, phone, internet, travel, seminars, conferences, assistants, consultants, and accountants.
  • Home-office expenses for the business use portion of a trader’s home (share of the rent, mortgage interest, real estate tax, depreciation on home, utilities, repairs, insurance, and all other home costs).
  • Margin interest expenses (not limited to investment income).
  • Stock-borrow fees for short-sellers.
  • Internal-use software for automated trading systems.

Business deductions don’t include the following:

  • Vehicles. (Traders don’t use autos daily for business.)
  • Commissions are part of the trading gain or loss.

LLC partnerships and S-Corps
Submit Form 1065 for a general partnership or multi-member LLC choosing partnership treatment. Submit Form 1120-S for an S-corporation. Forms 1065 and 1120-S issue Schedule K-1s to the owners, so taxes are paid at the owner level rather than the entity level, thereby avoiding double taxation. (Partnership K-1, S-Corp K-1.)

Ordinary income or loss (primarily business expenses) is summarized on Form 1040 Schedule E rather than in detail on Schedule C. Section 179 depreciation is broken out separately on Schedule E, along with unreimbursed partnership expenses (UPE), including home-office expenses. For an S-Corp, use an accountable reimbursement plan before year-end rather than UPE.

Trading is not a passive loss activity
Under the “trading rule” exception in Section 469 passive-activity loss rules, trading business entities are considered “active” rather than “passive-loss” activities, so losses are allowed in full on Form 1040 Schedule E in the non-passive income column.

Schedule K-1
Portfolio income (interest and dividends) is stated separately on the partnership and S-Corp Schedule K-1s and passed through to the individual owner’s Schedule B. Capital gains and losses pass through to Schedule D in summary form.

Net taxes don’t change; pay them on the individual level. Pass-through entities file Form 8949 and Form 4797 at the entity level. Schedule K-1 line one, “ordinary business income (loss),” consolidates Form 4797 ordinary income or loss with business expenses, and it’s a net income amount if trading gains exceed business expenses. The entity also reports Section 1256 contracts and passes through lower 60/40 capital gains rates to the owners.

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

See Entity Solutions, Retirement Plan Solutions, and 2022 Year-End Tax Planning For Traders.

The 20% qualified business income deduction
Per TCJA, the 2022 partnership and S-Corp Schedule K-1s report QBI (Section 199A) income, wages, and property factors and whether the business is a specified service trade or business (SSTB). S-corp wages can take advantage of the QBI phase-out range. A sole proprietor using Section 475 is also eligible for the QBI deduction. Look to TTS trading gains on Form 4797 Part II, less Schedule C TTS expenses.

See About Form 7203, S Corporation Shareholder Stock and Debt Basis Limitations (www.irs.gov/forms-pubs/about-form-7203).

Common errors on tax return filings for traders

  • Some accountants intuitively think that TTS traders should enter trading income, loss, and expenses like other sole proprietors on Schedule C. That’s wrong and often causes an IRS notice or exam.
  • Some traders try to deduct significant capital losses on Schedule C after missing the Section 475 MTM election deadline for ordinary gain or loss treatment. They try to evade wash sale (WS) loss adjustments and capital loss limitations.
  • Section 475 trades are reported in detail on Form 4797 Part II ordinary gains and losses, not on Schedule C.
  • Some traders use TTS and 475 when they should not.

SE tax errors

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

Adjusted gross income (AGI) errors

  • Some sole proprietor TTS traders incorrectly contribute to a retirement plan based on trading income and end up with an “excessive contribution” subject to tax penalties.
  • Some mistakenly take an AGI deduction for self-employed health insurance premiums, which also requires SEI, and trading income is not SEI.
  • A TTS trader needs an S-Corp to arrange retirement and health insurance deductions before the year-end.

Net investment tax errors
Include trading gains and losses in net investment income (NII) for calculating ACA 3.8% net investment tax (NIT).

  • Some traders omit to deduct TTS trading expenses from NII.
  • You cannot deduct investment fees and expenses from NII.

See Tax Center: ACA Net Investment Income Tax.

Tax extensions and tax payments are due

Extensions
The 2022 income tax returns for individuals are due by April 18, 2023 — however, most active traders aren’t ready to file a complete tax return by then. Some brokers issue corrected 1099-Bs right up to the deadline or even beyond.

Many partnerships and S-Corps file extensions by March 15, 2023, and don’t issue final Schedule K-1s to investors until after April 18.

Traders don’t have to rush to complete their tax returns by April 18. They can take advantage of a simple one-page automatic extension and pay taxes owed to the IRS and state. Traders can request an automatic six-month extension to file individual federal income tax returns until Oct. 16, 2023.

Most states offer the same extension terms (pay them, too), or they might accept the federal extension if no balance is due the state. Check with your state beforehand.

The 2022 Form 4868 instructions indicate how easy it is to get this automatic extension — no reason is required. It’s an extension to file a complete tax return, not an extension to pay taxes owed. The taxpayer should estimate and report what they think they owe for 2022 based on the tax information received.

Avoid late-filing and late-payment penalties
We suggest taxpayers learn how the IRS and states assess late-filing and late-payment penalties so they can avoid or reduce them.

If taxpayers cannot pay the taxes owed, they should estimate the balance due by April 18 and report it on the extension. Be sure to at least file the automatic extension on time to avoid the late-filing penalties, which are much higher than the late-payment penalty. See the 2022 Form 4868, page two, for an explanation of how to calculate these penalties. 

Avoid underestimated tax penalties
Some traders made significant trading gains in 2022. Some used the estimated tax payment “safe harbor” exception to cover their 2021 tax liability with the fourth quarter (Q4) 2022 estimated tax payment made by January 17, 2023. They plan to pay the balance of taxes owed by April 18, 2023 and should consider setting aside and protecting those funds. Some will risk their tax funds in the markets. Taxpayers should be careful because losing the funds will cause significant trouble later in the year.

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

See Tax Relief in Disaster Situations.

SALT cap workaround
TCJA capped state and local income, sales, and property taxes (SALT) at $10,000 per year ($5,000 for married filing separately) and did not index it for inflation. About 25 states enacted SALT cap workaround laws.

Search “(Your state) SALT cap workaround” to learn the details for your state. Most states follow a blueprint approved by the IRS.

Generally, it would be best if you elected to make a “pass-through entity” (PTE) payment on a partnership or S-Corp tax return filed by your business. It doesn’t work with a sole proprietorship filing a Schedule C. PTE is a business expense deduction shown on the state K-1, like a withholding credit.

Most states credit the individual’s state income tax liability with the PTE amount. Essentially, you convert a non-deductible SALT itemized deduction (over the cap) into a business expense deduction from gross income. Act well before year-end; otherwise, you might delay the benefit to next year. Learn the rules of your state.

See our recent Webinars and recordings covering this content.


Traders Should Focus On Q4 Estimated Taxes Due January 18

January 10, 2022 | By: Robert A. Green, CPA | Read it on

Many traders have substantial trading gains for 2021, and they might owe 2021 estimated taxes paid to the IRS quarterly. Unlike wages, taxes aren’t withheld from trading gains. Others can wait to make tax payments until April 18, 2022, when they file their 2021 tax return or extension.

The first three quarterly estimated tax payments were due April 15, June 15, and September 15, 2021, and the quarter four payment is due on January 18, 2022. Many new traders didn’t submit estimated payments for the first three quarters, waiting to see what Q4 brings. Also, some traders view skipping estimated tax payments like a margin loan with interest rates of 3% for Q1 and Q2 2021. With full transparency at year-end, traders can better assess the payment they should make for Q4 payments to minimize their underpayment penalties and interest.

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

Activity in Jan. 2022 can trigger wash sale losses for 2021, thereby creating more income in 2021.

Suppose your 2020 tax liability was $40,000, and AGI was over $150,000. Assume 2021 taxes will be approximately $100,000, and you haven’t paid estimates going into Q4. Using the safe-harbor rule, you can spread out the payment, submitting $44,000 (110% of $40,000) with a Q4 voucher on January 18, 2022, and paying the balance of $56,000 by April 18, 2022. This is an excellent option to consider instead of sending $90,000 in Q4 (90% of $100,000). Consider setting aside that tax money due April 18, 2022, rather than risking it in the financial markets in Q1 2022. I’ve seen some traders lose their tax money owed and get into trouble with the IRS. (See the example below). 

If your 2020 income tax liability is significantly higher than your 2021 tax liability, consider covering 90% of the current year’s taxes with estimated taxes. Check your state’s estimated tax rules, too.

In the above example, the trader should calculate the underpayment of estimated tax penalties for Q1, Q2, and Q3 on the 2021 Form 2210. Consider using Form 2210’s Annualized Income Installment Method if the trader generated most of his trading income later in the year. The default method on 2210 allocates the annual income to each quarter, respectively.

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

A forewarning: The recent market-sell off in January 2022 reminds me of similar circumstances in a few prior years. Here’s an example of what to avoid in 2022. Joe Trader has massive capital gains taxes to pay for 2021. However, due to a market correction in early 2022 and being on the wrong side of many trades, Joe might incur significant capital losses in early 2022 in trading securities (equity options and equities). Unfortunately, Joe might lose much of the tax money he owes the IRS and state for 2021 taxes. Investors will get stuck with a $3,000 capital loss limitation in 2022 and must carry over capital losses to subsequent years. However, Joe is eligible for trader tax status (TTS), so he submits a 2022 Section 475 election to the IRS by April 18, 2022, for ordinary gain or loss treatment with mark-to-market accounting.

With Section 475, Joe’s 2022 trading losses are “ordinary” and offset his other 2022 income, like retirement plan distributions. However, the 2017 TCJA legislation has an “excess business loss” (EBL) limitation in 2022 of $540,00 (married)/$270,00 (other taxpayers). EBL over the limit becomes a net operating loss (NOL) carryforward, which offsets income of any kind in subsequent years. Unfortunately, TCJA doesn’t permit net operating loss (NOL) carrybacks for 2022. Before 2018, traders could carry back massive NOLs to replenish their trading capital and stay in business.

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

Star Johnson, CPA, contributed to this blog post.


The IRS postponed the 2020 individual tax deadline to May 17

April 6, 2021 | By: Robert A. Green, CPA

The IRS postponed the 2020 individual tax filing and payment deadline to May 17, 2021, including the 2021 Section 475 election. For Texas, Oklahoma, and Louisiana residents, the deadlines are June 15, 2021. 

April 13, 2021: The IRS continues to assert that 2021 first quarter estimated tax payments are due April 15, even though they postponed the 2020 individual tax filing and payment deadline to May 17, 2021. See IRS notice Electing To Apply a 2020 Return Overpayment From a May 17 Payment with Extension Request to 2021 Estimated Taxes

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

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

Feb. 22, 2021: For residents of Texas, Oklahoma, and Louisiana, the IRS postponed the April 15, 2021 tax filing and payment deadline until June 15, 2021, after a federal disaster declaration in February 2021 due to winter storms. It also extended the 2021 Q1 estimated income tax payment deadline from April 15 to June 15, 2021. The delay includes various 2020 business returns due on March 15, including partnerships and S-Corps. The postponement also applies to the 2021 Section 475 election for individuals and pass-through entities in these three states.


Traders Should Focus On Q4 Estimated Taxes Due Jan. 15

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

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

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

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

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

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

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

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

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

Darren Neuschwander CPA contributed to this blog post.