Category: Tax Compliance

Investment Fees Are Not Deductible But Borrow Fees Are

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

The Tax Cuts and Jobs Act suspended “certain miscellaneous itemized deductions subject to the two-percent floor,” which includes “investment fees and expenses.” However, the new law retained “other miscellaneous deductions” not subject to the two-percent floor, including short-selling expenses like stock borrow fees.

While individual taxpayers may no longer deduct investment fees and expenses on Schedule A starting in 2018, they are still entitled to deduct investment interest expenses, up to net investment income, as calculated on Form 4952.

The new law (page 95) has a complete list of suspended miscellaneous itemized deductions including “expenses for the production or collection of income.” That list does not include short-selling expenses. Section 67(b) excludes certain deductions from the “2-percent floor on miscellaneous itemized deductions;” including (8) “any deduction allowable in connection with personal property used in a short sale.”

DHN_AW_logo_Daily_News

This blog post was their Top Story on July 16

Carrying charges vs. itemized deductions
Because investment fees and expenses are no longer deductible, some accountants might consider a Section 266 election to capitalize investment management fees as “carrying charges” to deduct them from capital gains and losses. But that won’t work: The IRS said taxpayers could not capitalize investment management fees under Section 266 because they are managerial rather than transactional.

Short-sellers probably could capitalize borrow fees under Section 266 because they are transactional. However, it’s safer to deduct these short-sale costs as “Other Miscellaneous Deductions” on Schedule A (Itemized Deductions) line 28. The new tax law suspended the Pease itemized deduction limitation, so the deduction has full effect on lowering taxable income. One concern: The IRS lists all Section 67(b) exclusion items in the instructions for Schedule A line 28, but it left out (8) for short-sale expenses. The code has substantial authority, and it’s reasonable to conclude that Schedule A instructions for other miscellaneous deductions on line 28 are not an exhaustive list.

Stock borrow fees
Short selling is not free; a trader needs the broker to arrange a loan of stock.

Brokers charge short sellers “stock borrow fees” or “loan premiums.” Tax research indicates these payments are “fees for the temporary use of property.” Watch out: Some brokers refer to stock borrow fees as “interest expense,” which confuses short sellers.

For tax purposes, stock borrow fees are “other miscellaneous deductions” on Schedule A line 28 for investors. Borrow fees are business expenses for traders qualifying for trader tax status (TTS). Borrow fees are not interest expense, so investors should not include them in investment interest expense deductions on Schedule A line 14.

It’s a significant distinction that has a profound impact on tax returns because investment expenses face greater limitations in 2017, and suspension in 2018 vs. investment interest expenses which are deductible up to investment income. Other miscellaneous deductions, including borrow fees, reported on Schedule A line 28 remain fully deductible for regular and alternative minimum tax (AMT).

Investment management fees cannot be capitalized
In a 2007 IRC Chief Counsel Memorandum, the IRS denied investors from capitalizing investment management fees paid to a broker as carrying charges under Section 266. Investors wanted to avoid alternative minimum tax (AMT) and other limitations on miscellaneous itemized deductions, the rules in effect before 2018. The problem is worse in 2018 with investment expenses entirely suspended.

The memo stated:

  • “Consulting and advisory fees are not carrying charges because they are not incurred independent of a taxpayer’s acquiring property and because they are not a necessary expense of holding property.
  • Stated differently, consulting and advisory fees are not strictly analogous to common carrying costs, such as insurance, storage, and transportation.”

Borrow fees might be able to be capitalized
Borrow fees seem to meet the requirements raised in the 2007 IRS Chief Counsel Memorandum for capitalization as carrying charges under Section 266. (It’s safer to deduct them as “other misc. deductions” on Schedule A line 28.)

Treasury Regulations under 1.266-1(b)(1) highlight several types of expenses that qualify as carrying charges, including taxes on various types of property, loan interest for financing property, costs to construct or improve the property, and expenses to store personal property.

A short seller cannot execute a short sale without borrowing securities and incurring borrow fees; they are a “necessary expense of holding” the position open, and “not independent” of the short-sale transaction. Borrow fees are not for the “management of property,” they are for the “acquisition, financing, and holding” of property.

Investment fees vs. brokerage commissions
Investors engage outside investment advisors and pay them advisory fees including management fees and/or incentive fees. Other investors may pay a broker a flat or fixed fee. These costs are managerial and not transactional, based on how many trades the manager makes. They cannot be capitalized under Section 266 according to the above IRS memorandum.

Brokerage commissions are transaction costs deducted from sales proceeds and added to cost basis on brokers’ trade confirmations and Form 1099-Bs. This tax reporting for brokerage commissions resembles a carrying charge.

Short-seller payments in lieu of dividends
When traders borrow shares to sell short, they receive dividends that belong to the lender — the rightful owner of the shares. After the short seller gets these dividends, the broker uses collateral in the short seller’s account to remit a “payment in lieu of dividend” to the rightful owner to make the lender square in an economic sense.

Section 263(h) “Payments in lieu of dividends in connection with short sales” require the mandatory capitalization of these payments if a short seller holds the short position open for 45 days or less (one year in the case of an extraordinary dividend).

If a short seller holds the short sale open for more than 45 days, payments in lieu of dividends are deductible as investment interest expense.

Investment interest expenses
Section 163(d)(3)(c) states, “For purposes of this paragraph, the term ‘interest’ includes any amount allowable as a deduction in connection with personal property used in a short sale.” A broad reading of “any amount” could be construed as opening the door to borrow fees, but I doubt that. “Any amount” refers to dividends in lieu of dividends held more than 45 days.

Under certain conditions, Section 266 allows capitalization of interest to finance a property.  Short sellers and others might want to consider the possibility of a Section 266 election on investment interest expense, too — especially if they plan a standard deduction or don’t have sufficient investment income. Excess interest is a carryover to subsequent tax years.

Transactional vs. managerial expenses
The following investment expenses seem transactional, and therefore eligible for capitalization in Section 266: Storage of precious metals or cryptocurrency, borrow fees on short sales, excess risk fees on short sales, and margin interest expenses.

The following investment expenses seem to be managerial rather than transactional, and therefore cannot be treated as carrying charges under Section 266: Investment management fees, fixed or flat fees paid to brokers, computers, equipment, software, charting, education, mentors, coaching, monthly data feed fees, market information, subscriptions, travel, meals, supplies, chatrooms, office rent, staff salaries and employee benefits, accounting, tax and legal services, and most other trading-related expenses.

Section 266 election statement and tax reporting

Consider filing a Section 266 election statement with your tax return, including on an extension.

  • “For tax-year 2018, taxpayer herewith elects under Code Section 266 and IRS Regulations 1.266-1 to capitalize short-selling expenses as carrying costs applied to capital gains and losses.”

Explain the election and tax treatment in a tax return footnote.

Report short-selling expenses for realized (closed) short sales as “expenses of sale or exchange” on Form 8949 (Sales and Other Dispositions of Capital Assets) in column (g) “adjustment to gain or loss.” Defer borrow fees paid on unrealized (open) short sales until realized (closed) in the subsequent year.

Consult a trader tax expert on using this potential alternative solution. If you get full deductibility on Schedule A, it’s safer to skip Section 266 capitalization, which the IRS might scrutinize.

Trader tax status
If a short-seller qualifies for trader tax status, then stock borrow fees and other short-selling expenses are deductible as business expenses from gross income.

If a TTS trader engages an outside investment manager, then investment advisory fees remain investment expenses.

Darren L. Neuschwander, CPA and Roger Lorence, JD contributed to this blog post.

Webinar July 19, 2018: Investment Fees Are Not Deductible But Borrow Fees Are. Recording available afterward. Click here.

Related blog posts: Short Selling: How To Deduct Stock Borrow Fees and Short Selling: IRS Tax Rules Are Unique.

 


Tax Extensions: 12 Tips To Save You Money

March 5, 2018 | By: Robert A. Green, CPA | Read it on

Individual tax returns for 2017 are due April 17, 2018, however, most active traders aren’t ready to file on time. Some brokers issue corrected 1099Bs right up to the deadline, or even beyond. Many partnerships and S-Corps file extensions by March 15, 2018, and don’t issue Schedule K-1s to investors until after April 17. Many securities traders struggle with accounting for wash sale loss adjustments.

The good news is traders don’t have to rush completion of their tax returns by April 17. They should take advantage of a simple one-page automatic extension along with payment of taxes owed to the IRS and state. Most active traders file extensions, and it’s helpful to them on many fronts.

Tip 1: Get a six-month extension of time
Request an automatic six-month extension of time to file individual federal and state income tax returns by Oct. 15, 2018. Form 4868 instructions point out how easy it is to get this automatic extension — no reason is required. It’s an extension of time to file a complete tax return, not an extension of time to pay taxes owed. Estimate and report what you think you owe for 2017 based on your tax information received.

Tip 2: Avoid penalties from the IRS and state for being late
Learn how IRS and state late-filing and late-payment penalties apply so you can avoid or reduce them to your satisfaction. 2017 Form 4868 (Application for Automatic Extension of Time To File U.S. Individual Income Tax Return) page two states:

“Late Payment Penalty. The late payment penalty is usually ½ of 1% of any tax (other than estimated tax) not paid by April 17, 2018. It is 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. 1. At least 90% of the total tax on your 2017 return is paid on or before the regular due date of your return through withholding, estimated tax payments, or payments made with Form 4868. 2. The remaining balance is paid with your return.

Late Filing Penalty. 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 $210 (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.”

Tip 3: File an automatic extension even if you cannot pay
Even if you can’t pay what you estimate you owe, make sure to file the automatic extension form on time by April 17, 2018. It should help avoid the late-filing penalty, which is ten times more than the late-payment penalty. So if you can’t pay in full, you should file your tax return or extension and pay as much as you can.

An example of late-payment and late-filing penalties: Assume your 2017 tax liability estimate is $50,000. Suppose you file an extension by April 17, 2018, but cannot pay any of your tax balance due. You file your actual tax return on the extended due date of Oct. 15, 2018, with full payment. A late-payment penalty applies because you did not pay 90% of your tax liability on April 17, 2018. 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 like a 6% margin loan.

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). Interest is also charged on taxes paid after April 17, 2018.

Tip 4: Add a payment cushion for Q1 2018 estimated taxes due
Traders with 2018 year-to-date trading gains and significant tax liability in the past year should consider making quarterly estimated tax payments this year to avoid underestimated tax penalties.

I recommend the following strategy for traders and business owners: Overpay your 2017 tax extension on April 17, 2018, and plan to apply an overpayment credit toward Q1 2018 estimated taxes. Most traders don’t make estimated tax payments until Q3 and 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 a better idea to pay an extra amount for the extension to set yourself up for three good choices: A cushion on 2017 if you underestimated your taxes, an overpayment credit toward 2018 taxes, or a tax refund for 2017 if no 2018 estimated taxes are due.

Tip 5: Consider a 2018 Section 475 MTM election
Traders eligible for trader tax status should consider attaching a 2018 Section 475 election statement to their 2017 tax return or extension. These are due by April 17, 2018, for individuals and corporations and March 15 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). Furthermore, the 20% pass-through deduction on qualified business income subject to taxable income limitations applies to Section 475 income. (Read Consider 475 Election By Tax Deadline To Save Thousands and How To Become Eligible For Trader Tax Status Benefits.)

Tip 6: File when it’s more convenient for you
Sophisticated and wealthy taxpayers know the “real” tax deadline is Oct. 15, 2018, for individuals and Sept. 17, 2018, for pass-through entities, including partnership and S-Corp tax returns. Pass-through entities file tax extensions by March 15, 2018. (See March 15 Is Tax Deadline For S-Corp And Partnership Extensions And Elections.)

You don’t have to wait until the last few days of the extension period like most wealthy taxpayers. 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 a wise strategy for traders to apply overpayment credits toward estimated taxes owed on current-year trading income. You want to look like you’re going to be successful in the current tax year.

The additional time helps build tax positions like qualification for trader tax status in 2017 and 2018. It may open opportunities for new ideas on tax savings. A rushed return does not. For example, a significant trading gain or loss during the summer of 2018 could affect some decision-making about your 2017 tax return.

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 2017 IRA contributions is April 17, 2018. If you did a Roth IRA conversion in 2017, the extension adds six months of time to recharacterize (unwind) the conversion. That may come in handy if the stock market drops in Q2 and Q3 2018.

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 tax information received and estimates for missing data.

Your accountant begins your tax compliance (preparation) engagement, and he or she cuts it off when seeing a solid draft to use for extension filing purposes. Your accountant will wait for final tax information to arrive after April 17, 2018. 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 17 with minor details in a rush to file a complete tax return. Accounting firms with high standards of quality 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 17. The capital loss carryover impacts your decision to elect Section 475 MTM for 2018 by April 17, 2018, but an estimate is sufficient.

Consider wash-sale loss rules on securities: If you know these adjustments won’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 17. (Consider our trade accounting service.)

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 coin trade accounting programs to generate Form 8949.

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

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, 2018, to file their tax return and pay any amount due without requesting an extension. (See Form 4868 page 2, and the IRS website.)

Bonus Tip: FinCEN grants permanent automatic extensions for FBARs
Over a year ago, “The Treasury Department’s Financial Crimes Enforcement Network (FinCEN) announced that, to implement the new due date for FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR), of April 15 (April 18 for 2017), it will automatically grant all taxpayers filing the form a six-month extension every year to Oct. 15 (which will be Oct. 16, 2017, because Oct. 15 is a Sunday). FinCEN explained that this six-month extension will be automatic each year and that taxpayers do not have to request extensions,” per Journal of Accountancy.

Cryptocurrency (coin) is not currency; the IRS labels it “intangible property.” IRS flow charts for what’s reportable on FBAR and or Form 8938 (Statement of Foreign Financial Assets) indicate that intangible property is not reportable on those forms. Some tax attorneys suggest including cryptocurrency held on foreign coin exchanges on FBAR forms to play it safe. FinCEN officials said they are not expecting to see cryptocurrency (“virtual currency”) reported on FBARs for 2017. If a U.S. resident sells cryptocurrency for currency and holds that currency on a foreign coin exchange, that currency is reportable on FBAR. FinCEN recently raised its significant penalty amounts for failure to file FBAR to keep pace with inflation.

 

 

 


March 15 Is Tax Deadline For S-Corp And Partnership Extensions And Elections

March 3, 2018 | By: Robert A. Green, CPA | Read it on

March 15, 2018, is the deadline for filing 2017 S-Corp and partnership tax returns, or extensions, 2018 S-Corp elections, and 2018 Section 475 elections. Don’t miss any of these tax filings or elections; it could cost you.

2017 S-Corp and partnership tax extensions
Extensions are easy to prepare and e-file for S-Corps and partnerships since they pass through income and loss to the owner, usually an individual. Pass-through entities are tax-filers, but not taxpayers. 2017 individual and calendar-year C-Corp tax returns or extensions with taxes owed are due April 17, 2018.

Some states have S-Corp franchise taxes, excise taxes, or minimum taxes, and payments are usually due with the extensions by March 15.  LLCs filing as a partnership may have minimum taxes or annual reports due with the extension by March 15.

2017 S-Corp and partnership extensions give six additional months to file a tax return, by Sep. 17, 2018.

The IRS late filing penalty regime for S-Corps and partnerships is similar. The IRS assesses $200 per owner, per month, for a maximum of 12 months. Taxpayers may request penalty abatement based on reasonable cause. Ignoring the extension deadline is not reasonable cause. There is also a $260 penalty for failure to furnish a Schedule K-1 to an owner on time, and the penalty is higher if intentionally disregarded. States assess penalties and interest, often based on payments due.

2018 S-Corp elections
Traders qualifying for trader tax status and interested in employee benefit plan deductions, including health insurance and retirement plan deductions, probably need an S-Corp. They should consider a 2018 S-Corp election for an existing trading entity, due by March 15, 2018, or form a new entity and file an S-Corp election within 75 days of inception. Most states accept the federal S-Corp election, but a few states do not; they require a separate S-Corp election filing by March 15. If you overlooked filing a 2017 S-Corp election by March 15, 2017 and intended to elect S-Corp tax treatment as of that date, you may qualify for IRS relief. (See Late Election Relief.)

2018 Section 475 MTM elections for S-Corps and partnerships
Traders, eligible for trader tax status, should consider attaching a 2018 Section 475 election statement to their 2017 tax return or extension due by March 15, 2018, for partnerships and S-Corps, or by April 17, for individuals and corporations. Section 475 turns capital gains and losses into ordinary gains and losses thereby avoiding the capital loss limitation and wash sale loss adjustments (tax loss insurance). There are also benefits to 475 income: The 20% pass-through deduction on qualified business income subject to taxable income limitations. (Read Consider 475 Election By Tax Deadline To Save Thousands.)

If a trader wants to revoke a prior year Section 475 election, a revocation election statement is due by March 15, 2018. (See New IRS Rules Allow Free And Easy Section 475 Revocation.)

Tax compliance services
Green, Neuschwander & Manning LLC offers tax compliance services to traders, which include tax preparation and tax planning. If you haven’t signed up yet for our entity and individual service, do so immediately, so we can prepare your extensions and consider the above elections on time. Alternatively, discuss the above matters with Robert A. Green, CPA in a consultation.

 


How To Avoid An IRS Underpayment Penalty For June 15

June 9, 2017 | By: Robert A. Green, CPA

Forbes

Read it on Forbes

There are two important tax deadlines for individuals on June 15: quarterly estimated income taxes for 2017, and the 2016 tax deadline for U.S. residents living outside the U.S.

Excerpts from 2017 Federal Tax Calendar IRS Tax Due Dates for the 2017 Calendar Year:

“Individuals: If you are a U.S. citizen or resident alien living and working (or on military duty) outside the U.S. and Puerto Rico, file your 2016 income tax return (Form 1040) and pay any tax due. If you want a 4-month extension of time to file your return, use Form 4868 to extend your filing deadline to October 16. (The IRS grants the above individuals two additional months to file compared to U.S. residents living and working in the U.S. who had to file income tax returns or extensions by April 18, 2017.)”

“Individuals: If you are not paying your 2017 income tax through withholding (or you will not pay enough tax during the year that way), pay the second installment of your 2017 estimated tax. Use Form 1040-ES (Estimated Tax for Individuals). For more information, see IRS Publication 505 (Tax Withholding and Estimated Tax).” (Read a brief IRS explanation What Is Estimated Tax & Who Does It Apply To?.)

The four quarters for estimated taxes are:

• Q1: Jan. 1 — March 31, deadline is April 18, 2017

• Q2: April 1 — May 31, deadline is June 15, 2017

• Q3: June 1 — Aug. 31, deadline is Sept. 15, 2017

• Q4, Sept. 1 — Dec. 31, deadline is Jan. 15, 2018

Exceptions: Generally, you do not have to pay an underpayment penalty if either: Your total tax is less than $1,000, or you had no tax liability last year.

Estimated tax safe harbor rule. If your 2016 adjusted gross income (AGI) was more than $150,000 ($75,000 if you are married filing a separate return), you must pay the smaller of 90% of your expected tax for 2017 or 110%* of the tax shown on your 2016 return to avoid an estimated tax penalty. (*If your AGI is under these high-income thresholds, cover 100% of the prior year.)

Underpayment penalty: Traders with 2017 year-to-date trading gains should consider making quarterly estimated tax payments during the year to avoid an underpayment penalty. For 2016, the underpayment penalty rate was 4%. Some traders think this a reasonable price, sort of like another margin loan from a broker. But, the underpayment penalty is not tax deductible, whereas margin interest is.

Consider using the “Annualized Income Installment Method” if that generates a better result than the “Regular Method.” If you make the bulk of your trading income at the end of the year, the annualized method is better. (See the instructions for Form 2210 Underpayment of Estimated Tax by Individuals, Estates, and Trusts.)

Three common scenarios for traders:

1. You left a high-paying job in late 2016, and your only activity for 2017 is trading, with significant profits year-to-date (YTD). It’s probably wise to make a Q2 estimated tax payment. If you did not pay a Q1 estimate and you don’t have an overpayment credit from 2016, then pay enough for Q2 to catch up for YTD. Under the safe harbor rule, covering your 2016 tax liability will be a substantial amount. Determine whether it’s preferable to pay 90% of 2017 taxes if that is a lower cost. The software used for preparing your 2016 tax return can generate the estimated tax payment vouchers based on the safe harbor exception or 90% of the current year. The state estimated tax rules vary, some require a different percentage for the current year vs. the federal 90%.

2. Your income tax liability for 2016 was small, and you have significant trading gains in 2017. Assume the safe harbor rule is best and cover the prior year tax liability.

3. You have trading losses in 2017. You may not owe estimated taxes for Q2 2017.

Traders face a quandary with estimated taxes:
If you pay what you owe for Q2, you may regret it with trading losses later in the year. You’ll be stuck waiting for a tax refund or applying an overpayment credit towards 2018 taxes. You won’t have that money available for trading capital for the remainder of 2017. Many traders don’t make estimated tax payments until Q3 and or Q4 when they have more visibility on trading results.

Loophole for S-Corp traders:
Traders eligible for trader tax status often use an S-Corp to deduct health insurance premiums and retirement plan contributions. They need to execute officer compensation through payroll in Dec. 2017 to unlock those employee benefits. Traders can withhold a significant portion of their salary as federal and state withholding tax. That alleviates estimated income taxes due. The loophole is that the IRS treats payroll tax withholding reported on a Form W-2 as made throughout the year, even though it’s all withheld in December.

Tax reform:
Congress and President Trump are working on tax reform in 2017, and considering delays; I expect changes won’t be effective until 2018. There’s a small chance Congress could make tax reform retroactive to 2017, which would change 2017 estimated tax payment calculations. I think individuals should make 2017 Q2 estimated tax payments based on current tax law. Let’s see if there is any concrete news on tax reform before the Q3 deadline of Sept. 15, 2017.

Our clients should contact their assigned CPA if they need help with 2017 quarterly estimated tax vouchers.

 


If You Can’t Deduct All Your Trading Losses Consider Section 475 Election

April 6, 2017 | By: Robert A. Green, CPA

Forbes

If You Can’t Deduct All Your Trading Losses Consider Section 475 Election

Individuals qualifying for trader tax status (TTS) with a significant trading loss in the first quarter of 2017, should consider a 2017 Section 475 MTM election, due by April 18, 2017. (S-Corps and partnerships had to make this election by March 15, 2017.) Profitable traders should consider the election, too.

Avoid loss limitations including a $3,000 capital loss limitation for 2017, capital loss carryovers to 2018, and wash sale loss adjustments. The Section 475 election converts capital losses into unlimited ordinary business losses, which may generate tax savings immediately. For example, a $50,000 Section 475 ordinary loss offsets wage income without limitation, whereas a capital loss is limited to $3,000 against other income, including wages. I refer to Section 475 as “tax loss insurance,” and it’s one of the most attractive tax benefits for TTS traders. April 18th is the deadline, so make the right decision and act fast.

Here are two scenarios where the election is wise

1. TTS individual trader has trading losses of $50,000 for Q1 2017, comprised of $25,000 losses in securities, and $25,000 losses in futures (Section 1256 contracts). He also has a capital loss carryover of $100,000 from 2016 into 2017.

Starting the year 2017, this trader hoped to generate capital gains to use up his capital loss carryover, figuring the next $100,000 of capital gains is tax-free. But, things went awry, and he generated trading losses in 2017.

Smart move: File a 2017 Section 475 MTM election on securities and Section 1256 contracts by April 18, 2017. It doesn’t make sense adding to a significant capital loss carryover. Next, create an LLC trading company, which files a partnership or S-Corp tax return. That entity may generate capital gains to pass through to the individual level to use up the $100,000 capital loss carryover. If the trading entity incurs trading losses, it can elect Section 475 internally, within 75 days of its inception. Plan to revoke the individual Section 475 election on Section 1256 contracts by April 15, 2018, for 2018.

2. TTS sole proprietor trader has trading gains of $40,000 for YTD 2017 in securities and Section 1256 contracts. She does not have a capital loss carryover or unrealized capital losses, so she has a clean slate for electing Section 475. She also trades IRA accounts, so she faces a potential wash sale loss problem. If she incurs a trading loss in her taxable trading account and buys back a substantially identical position 30-days before or after in her IRA account, she will never get the benefit of that tax loss in either taxable or IRA accounts. That’s far worse than a deferred wash sale loss at year end. (Broker 1099Bs don’t account for wash sales between taxable and IRA accounts, whereas the IRS requires taxpayers to do so.)

Smart move: File a 2017 Section 475 MTM election on securities only, not including Section 1256 contracts, by April 18, 2017. She retains lower 60/40 capital gains tax rates on Section 1256 contracts, with 60% being a long-term capital gain taxed at lower rates. The Section 475 election on securities exempts her from wash sale loss adjustments in her taxable accounts, which also prevents wash sale losses with her IRA trading accounts. If she incurs a significant trading loss later in the year in her taxable accounts, she will be glad to have ordinary loss treatment rather than a capital loss limitation.

Section 475 MTM election statement
Type the below statement on a sheet of paper with your name and social security number (or entity EIN) up top.

“Under IRC 475(f), the Taxpayer at this moment elects to adopt the mark-to-market method of accounting for the tax year ended Dec. 31, 2017, and subsequent tax years. The election applies to the following trade or business: Trader in Securities as a sole proprietor (for securities only and not Section 1256 contracts).”

If you want to include Section 1256 contracts, modify the language accordingly. For external Section 475 MTM elections, this is just the first part of the election process – and the most important part. You also have to file a timely 2017 Form 3115 with your 2017 tax return in 2018 (with a duplicate copy to the IRS National Office).

Learn more about Section 475 MTM in Green’s 2017 Trader Tax Guide. There are many nuances, myths, and scenarios to consider.

Section 475 could be an important election for you, so get it right! Don’t be one of the thousands who complain they missed the boat, which sails on April 18th or messes up the process. If you already filed your 2016 tax return or extension, you should send the IRS a letter by April 18, 2017, explaining you left out the election. Consult a trader tax expert, preferably us.


5 Tips To File Tax Extensions That Will Save You Money

March 11, 2017 | By: Robert A. Green, CPA

Forbes

5 Tips For Filing Tax Extensions That Will Save You Money.

2016 individual tax returns are due April 18, 2017. But, most active traders aren’t ready to file on time. Some brokers issue corrected 1099Bs close to, or after the deadline. Many partnerships and S-Corps file extensions by March 15, 2017, and don’t issue Schedule K-1s to investors until after April 18. Many securities traders struggle with accounting for wash sale loss adjustments and they aren’t ready to file.

Traders face more complexity than employees with easy-to-report W-2 income, portfolio income, and itemized deductions. Traders have involved trade accounting issues, trader tax status analysis and reporting strategies, business vs. investment expenses, and other unique considerations.

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

Six-month extension of time to file
Request an automatic six-month extension of time to file individual federal and state income tax returns by Oct. 16, 2017. Form 4868 instructions point out how easy it is to get this automatic extension — no reason is required. It’s an extension of time to file a complete tax return, not an extension of time to pay taxes owed. In good faith, estimate and report what you think you owe for 2016 based on your tax information received.

Avoid penalties from the IRS and state for being late
Learn how IRS and state late-filing and late-payment penalties apply so you can avoid or reduce them to your satisfaction. See 2016 Form 4868 page two for the full explanation of federal late-payment penalties and late-filing penalties, including how taxpayers may request penalty abatement.

File a return or automatic extension on time even if you can’t pay what you estimate you owe. In most cases, the late-filing penalty is ten times more than the late-payment penalty. So if you can’t pay in full, you should file your tax return or extension and pay as much as you can.

An example of late-payment and late-filing penalties
Assume you estimate your 2016 tax liability is $50,000. Suppose you file an extension by April 18, 2017, but don’t pay any of your tax balance due. You file your actual tax return on the extended due date of Oct. 16, 2017, with full payment. A late-payment penalty applies because you did not pay 90% of your tax liability on April 18. The late-payment penalty is $1,500 (6 months late x 0.5% per month x $50,000). Some traders view a late-payment penalty like a 6% margin loan. I’ve seen traders skip an extension payment to trade the tax money longer, only to lose it and cause bigger tax penalties. That’s risky.

By simply filing the extension on time in the above example, you avoided a late-filing penalty of $11,250 (6 months late x 5% per month (25% max), less late-payment penalty factor of 2.5%, equals a net late-filing penalty of 22.5% x $50,000). Interest is also charged on taxes paid after April 18.

Add a payment cushion for Q1 2017 estimated taxes due
Traders with 2017 year-to-date trading gains should consider making quarterly estimated tax payments during the year to avoid underestimated tax penalties. For 2016, a 4% rate applies for the following periods — April 16 through June 30, July 1 through September 30, October 1 through December 31, and January 1, 2017, through April 15, 2017. (See Underpayment Penalty for 2016.)

I recommend the following strategy for traders and business owners: Overpay your 2016 tax extension on April 18, 2017, and plan to apply an overpayment credit toward Q1 2017 estimated taxes. Most traders don’t make estimated tax payments until Q3 and or Q4 when they have more visibility on trading results. Why pay estimated taxes for Q1 and Q2 if you incur substantial trading losses later in the year?

It’s a better idea to pay an extra amount for the extension. That would give three good choices: A cushion on 2016 if you underestimated your taxes, an overpayment credit toward 2017 taxes, or a tax refund for 2016 if no 2017 estimated taxes are due.

Congress is considering changes to Obamacare taxes
The IRS recently announced a change of course: It will accept “silent” 2016 tax returns, where the taxpayer does not check the box for having ACA-compliant health insurance coverage or a qualified exemption from the Affordable Care Act’s individual health insurance mandate and shared responsibility payment. The IRS said it still expects taxpayers to comply with all ACA taxes, including this shared responsibility payment. ACA taxes include Form 8962 (Premium Tax Credit) where a taxpayer may owe the IRS a “Repayment of Excess Advance Payment” (a clawback) if the taxpayer’s income is higher than estimated in applying for government subsidies on a health insurance marketplace or exchange.

President Trump issued an “Executive Order Minimizing the Economic Burden of the Patient Protection and Affordable Care Act Pending Repeal,” and it applies to the IRS. The White House and Congress are working on an ACA “repeal and replace” bill, and the House’s current version included repeal of the ACA individual health insurance mandate and shared responsibility payment, valid for the tax year 2016 and subsequent years. It’s wise to file an extension to wait and see the outcome of these potential changes.

Don’t get your hopes up for a retroactive repeal of the ACA 3.8% Net Investment Tax (NIT) on unearned income. The House bill calls for repeal of NIT beginning in 2018, so NIT should remain for 2016 and 2017.

Section 475 MTM elections
Individual, sole proprietor traders qualifying for trader tax status should consider a Section 475 MTM election for ordinary gain or loss treatment by the due date of April 18, 2017. Ordinary losses generate tax benefits faster than capital loss carryovers. Attach a Section 475 election statement to the federal Form 4868 and mail it by April 18, 2017, certified return receipt. You can’t e-file an extension with this election statement attached. You can elect Section 475 on securities only, or Section 1256 contracts, too. (Learn more about Section 475 in Green’s 2017 Trader Tax Guide, Chapter 2.)

Other benefits from filing extensions
Sophisticated and wealthy taxpayers know the “real” tax deadline is Oct. 16, 2017, for individuals and Sept. 15, 2017, for pass-through entities, including partnership and S-Corp tax returns. Pass-through entities file tax extensions by Mar. 15, 2017. (See March 15 Is The Tax Deadline For S-Corp And Partnership Extensions And Elections.)

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

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 a wise strategy for traders to apply overpayment credits toward estimated taxes owed on current-year trading income. You want to look like you’re going to be successful in the current tax year.

The additional time helps build tax positions like qualification for trader tax status in 2016 and 2017. It may open opportunities for new ideas on tax savings. A rushed return does not. For example, a significant trading gain or loss during the summer of 2017 could affect some decision-making about your 2016 tax return.

More options for retirement planning
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 2016 IRA contributions is April 18, 2017. If you did a Roth IRA conversion in 2016, the extension gives you six months of additional time to recharacterize (unwind) the conversion. That may come in handy if the stock market drops in Q2 and Q3 2017.

Working with 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 tax information received and estimates for missing information.

Your accountant begins your tax compliance (preparation) engagement, and he or she cuts it off when seeing a solid draft to use for extension filing purposes. Your accountant will wait for final tax information to arrive after April 18 to complete your tax return. 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 on your tax return in a rush to file a complete tax return. Accounting firms with high standards of quality 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 the last-minute. That doesn’t serve anyone well.

Securities traders should focus on trade accounting
If you know you’ll have a capital loss limitation of $3,000; 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.

Consider wash sale loss rules. If you know wash sale loss adjustments won’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.

For Section 1256 contracts, you can rely on the one-page 1099B showing aggregate profit or loss. For forex, you can depend on the broker’s online tax reports. Wash sales don’t apply to Section 1256 contracts and forex.

State extensions
Some states don’t require an automatic extension for overpaid returns; they accept the federal extension. If you owe state taxes, you need to file a state extension with payment. States tend to be less accommodating than the IRS in abating penalties, so it’s usually wise to cover your state taxes first if you’re short on cash. Check the extension rules in your state. They probably have good online information.

U.S. citizens or resident aliens residing overseas are allowed an automatic two-month extension until June 15, 2017, to file their tax return and pay any amount due without requesting an extension. Excerpt from the IRS website: “If you are a U.S. citizen or resident alien living and working (or on military duty) outside the U.S. and Puerto Rico, file your 2016 income tax return (Form 1040) and pay any tax due (by June 15, 2017). If you want a 4-month extension of time to file your return, use Form 4868 to extend your filing deadline to October 16. (Note that there are special provisions for military personnel who are stationed in a combat zone. For more information, see IRS Publication 3.)”


March 15 Is The Tax Deadline For S-Corp And Partnership Extensions And Elections

March 3, 2017 | By: Robert A. Green, CPA

Forbes

March 15 Is Tax Deadline For S-Corp And Partnership Extensions And Elections

March 15, 2017, is the deadline for filing 2016 S-Corp and partnership tax returns, or extensions, 2017 S-Corp elections, and 2017 Section 475 elections. Don’t miss any of these tax filings or elections; it could cost you.

2016 S-Corp and partnership tax extensions
Extensions are easy to prepare and e-file for S-Corps and partnerships since they pass through income to the owner, usually an individual. Pass-through entities are tax-filers, but not taxpayers. 2016 individual and calendar-year C-Corp tax returns or extensions with taxes owed are due April 18, 2017.

Some states have S-Corp franchise taxes, excise taxes, or minimum taxes, and payments are usually due with the extensions by March 15. (See A Few States Tax S-Corps: Traders Can Reduce It.) LLCs filing as a partnership may have minimum taxes or annual reports due with the extension by March 15.

The IRS changed the due date for partnerships: 2016 partnership tax returns or extensions are due March 15, 2017, the same due date as S-Corps. Last year, partnership tax returns were due April 18, 2016, the same due date as individuals. 2017 S-Corp and partnership extensions give six additional months to e-file a tax return, by Sep. 15, 2017.

The IRS late filing penalty regime for S-Corps and partnerships is similar. The IRS assesses $195 per owner, per month, for a maximum of 12 months. Taxpayers may request penalty abatement based on reasonable cause. Ignoring the extension deadline is not reasonable cause. States assess penalties and interest, often based on payments due.

2017 S-Corp elections
Traders qualifying for trader tax status and interested in employee benefit plan deductions, including health insurance and retirement plan deductions, probably need an S-Corp. They should consider a 2017 S-Corp election for an existing trading entity, due by March 15, 2017, or form a new entity and file an S-Corp election within 75 days of inception. Most states accept the federal S-Corp election, but a few states do not; they require a separate S-Corp election filing by March 15. If you overlooked filing a 2016 S-Corp election by March 15, 2016, and intended to elect S-Corp tax treatment as of that date, you may qualify for IRS relief. (See Late Election Relief.) (You are welcome to discuss an S-Corp election with Robert A. Green, CPA in a paid consultation.)

2017 Section 475 MTM elections for S-Corps and partnerships
Traders qualifying for trader tax status may elect Section 475 ordinary gain or loss treatment. Section 475 trades are exempt from wash sale loss adjustments on securities and the $3,000 capital loss limitation. I refer to Section 475 as “tax loss insurance” since it leads to quick tax refund checks. I recommend Section 475 for securities, but not Section 1256 contracts, to retain lower 60/40 capital gains rates in Section 1256. Section 475 does not apply to segregated investment positions. Section 475 MTM ordinary income does not use up capital loss carryovers.

“Existing taxpayers” including S-Corps and partnerships that file a 2016 tax return may attach a 2017 Section 475 MTM election statement to their 2016 federal entity tax return or extension, due by March 15, 2017. The second step is to file a 2017 Form 3115 (Application for Change in Accounting Method) with the 2017 entity tax return filing in 2018.

If a trading S-Corp or partnership has significant trading losses on securities and or Section 1256 contracts for the year-to-date period in 2017, it may be a good idea to elect Section 475 for ordinary loss treatment. If a trader wants to revoke a 2016 Section 475 election, a revocation election statement is due by March 15, 2017. (See New IRS Rules Allow Free And Easy Section 475 Revocation.)

Tax compliance services
Green, Neuschwander & Manning LLC offers tax compliance services to traders, which include tax preparation and tax planning. If you haven’t signed up yet for our entity and individual service, do so immediately, so we can prepare your extensions and consider the above elections on time. Alternatively, discuss the above matters with Robert A. Green, CPA in a paid consultation.

Darren Neuschwander CPA contributed to this blog post. 

 


Seven Powerful Ways Traders Save Money On 2016 Tax Returns

January 25, 2017 | By: Robert A. Green, CPA

Forbes

Seven Powerful Ways Traders Save Money On 2016 Tax Returns

Tax software and preparers come up short on traders; they mishandle trader tax status, forms, elections, the treatment of different financial products, entities, employee benefit deductions and investment expenses. Here are seven powerful ways traders save money this tax-filing season.

1. Use correct tax forms
The IRS hasn’t created specific tax forms for individual trading businesses. Traders enter gains and losses, portfolio income, business expenses and investment expenses on various forms. It’s often confusing. Which form should you use if you’re a forex trader? Which form is best for securities traders using the Section 475 MTM method? The different reporting strategies for the various types of traders make tax time not so cut-and-dried.

- Sole proprietor trading business: Other sole-proprietorship businesses report revenue, the cost of goods sold and expenses on Schedule C. But business traders qualifying for trader tax status (TTS) report only expenses on Schedule C. Trading gains and losses are reported on various forms, depending on the situation. In an entity, all trading gains, losses, and expenses are consolidated on the entity tax return — a partnership Form 1065 or S-Corp Form 1120-S. That’s one reason why we recommend entities for TTS traders.

- Sales of securities must be first reported on Form 8949, which then feeds into Schedule D (cash method) with 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.

- Business traders who elect and use Section 475 MTM on securities report their business trades (line by line) on Form 4797 Part II. MTM means open business trades are marked-to-market at year-end based on year-end prices. Business traders still report sales of segregated investments in securities (without MTM) on Form 8949. Form 4797 Part II (ordinary gain or loss) has unlimited business ordinary loss treatment and avoids capital loss limitations and wash sale loss treatment. Form 4797 losses are counted in net operating loss (NOL) calculations.

- Section 1256 contract traders (i.e., futures) should use Form 6781 (unless they elected Section 475 for commodities/futures; in that case, Form 4797 is used). 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”). Just enter that amount in summary form on Form 6781 Part I. If you have a large Section 1256 loss, consider a Section 1256 loss carryback election to carryback those losses three tax years, but only applied against Section 1256 gains in those years. If you want this election, check box D labeled “Net section 1256 contracts loss election ” on the top of Form 6781.

- Forex traders with Section 988 ordinary gains or losses who don’t qualify for TTS should use line 21 (other gross income or loss) on Form 1040. Traders who qualify for TTS should use Form 4797, Part II ordinary gain or loss. What’s the difference? Form 4797 Part II losses contribute to NOL carrybacks and carryforwards against any type of income, whereas Form 1040’s “other losses” do not. The latter can be wasted if the taxpayer has negative income. In that case, a contemporaneous capital gains election is better on the Section 988 trades. If you filed the contemporaneous Section 988 opt-out (capital gains) election, use Form 8949 for minor currencies and Form 6781 for major currencies. Forex uses summary reporting.

2. Maximize business expenses and fix Schedule C problems
Sole-proprietor business traders report business expenses on Schedule C and trading income/loss and portfolio-related income on other tax forms, which may confuse the IRS. It may automatically view a trading business’s Schedule C as unprofitable even if it has substantial net trading gains on other forms. This is one reason why I recommend an entity.

To mitigate this red flag, I advocate a special strategy to transfer a portion of business trading gains to Schedule C to “zero it out” if possible. Don’t report a net income on Schedule C as that would invite IRS computers to look for self-employment (SE) tax, which traders do not owe on trading income. (The exception is a full-fledged dealer/member of an options or futures exchange trading Section 1256 contracts on that exchange; they have self-employment income per Section 1402i.)

I strongly recommend that business traders always include well-written tax-return footnotes, explaining trader tax law and benefits, why and how you qualify for TTS (business treatment), whether you elected Section 475 MTM or opted out of Section 988, and other tax treatment, such as the income-transfer strategy. If you’re a part-time trader, use the footnotes to explain how you allocate your time between other activities and trading. Including footnotes with your return takes a step to address any questions the IRS may have about your qualification for TTS and the various aspects of its reporting on your return before it has a chance to ask you.

3. Use correct tax treatment of different financial products
Which financial products you trade and where you trade them can make a huge difference in tax savings. Capital gains vs. ordinary income: Most financial instruments — including securities, Section 1256 contracts, options, ETFs, indexes, precious metals and bitcoin held as a capital asset — are subject to capital gains treatment. By default, forex contracts and swap contracts are subject to ordinary gain or loss treatment. The distinction between ordinary and capital gains treatment makes a big difference.

The capital-loss limitation is a problem for traders and investors who may have trouble using up large capital-loss carryovers in subsequent tax years. Traders with TTS and a Section 475 MTM election have business ordinary-loss treatment, which is more likely to generate tax savings or refunds faster. Section 1256 contract traders enjoy lower 60/40 tax rates, summary reporting and no need for accounting.

4. Maximize benefits on an entity tax return
Partnership and S-Corp trading business tax returns show trading gains, losses and business expenses on one set of forms, plus the IRS won’t see the taxpayer’s other activities. That looks much better than a Schedule C.

Form 1065 is filed for a general partnership or multi-member LLC choosing to be taxed as a partnership. Form 1120S is filed for an S-corporation and an LLC electing to be taxed as an S-Corp. Forms 1065 and 1120S issue Schedule K-1s to the owners, so taxes are paid at the owner level rather than at entity level, thereby avoiding double taxation. Ordinary income or loss (mostly business expenses) is summarized on Form 1040 Schedule E rather than in detail on Schedule C (hence less IRS attention). Section 179 is broken out separately on Schedule E, along with unreimbursed partnership expenses (UPE) including home-office expenses.

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. Portfolio income (interest and dividends) is passed through to Schedule B. Capital gains and losses are passed through to Schedule D in summary form. Pass-through entities draw less IRS attention than a detailed Schedule C filing. Net taxes don’t change; they’re still paid on the individual level. Pass-through entities file Form 8949 and/or Form 4797 at the entity level.

5. Maximize employee benefit plan deductions
S-Corps provide additional tax breaks including opportunities for employee-benefit plans including retirement plans and health-insurance premium tax deductions; two breaks sole-proprietor and partnership traders can’t use unless they have a source of earned income. Health insurance is a great deduction through a trader S-Corp because there is no payroll tax due on that portion of W-2 wages.

6. File and report tax elections on time
Tax treatment elections can be confusing because the Section 475 MTM and Section 988 elections don’t have tax forms. New taxpayers — such as a new entity — file Section 475 MTM elections internally within 75 days of inception, but existing taxpayers file a statement by the due date of the prior year tax return or extension with the IRS and perfect it later with a Form 3115 filing by the deadline. It’s too late to elect Section 475 for 2016 taxes; the next opportunity is for 2017, by Mar. 15, 2017 for existing partnerships and S-Corps, and Apr. 18, 2017 for individuals.

The forex Section 988 capital gains election is only filed internally on a contemporaneous basis, at any time during the year, from that date going forward.

7. Maximize investment expenses
If you’re filing as an investor, report trading gains and losses as explained earlier. You can’t elect and use Section 475 MTM with Form 4797 ordinary gain or loss treatment, as that election requires TTS.
Report investment interest expense (margin interest) on Form 4952. It’s limited to investment income and investment expenses, and the balance is an investment interest expense carryover to the subsequent tax year(s). The deduction is taken on Schedule A where it may be subject to the Pease limitation, but it’s deductible for alternative minimum tax.

Report investment expenses as miscellaneous itemized deductions on Schedule A. Miscellaneous itemized deductions are only allowed in excess of 2% of adjusted gross income (AGI). The allowed amount is subject to the Pease limitation, and it’s not deductible for AMT. Many states limit or do not allow itemized deductions. Business expense treatment with TTS is much better.

Investment expenses are allowed for the production of investment income. Investment expenses exclude home office, education, seminars, travel to seminars and startup expenses. Computers and monitors are allowed if they are predominantly used for managing investments.

Don’t sell yourself short on tax breaks available for traders this tax season.

This blog post is a modified excerpt from Green’s 2017 Trader Tax Guide.

Attend our related Webinar or watch the recording afterward: 7 Ways To Save On 2016 Tax Returns For Traders (Lightspeed Trading)ttg_cover-200x258_2017-1-200x258


Four Key Tax Due Dates And Two Elections For Professional Traders

January 11, 2017 | By: Robert A. Green, CPA

Forbes

Four Key Tax Due Dates And Two Elections For Professional Traders

Don’t wait until the last minute to prepare and file your 2016 tax returns; that’s stressful, and it leads to errors and over-paying. Get organized now and comply with the below list of Tax Due Dates.

Try to file and pay your individual tax returns well before the April 18, 2017 deadline. If you cannot, then file an automatic extension to receive six-months additional time. Caution: It’s only an extension of time to file, not an extension of time to pay taxes owed. In good faith, estimate and report on the extension form what you think you owe for the tax year 2016 based on your tax information received. (Learn more in my blog post Don’t Sweat The Tax Deadline, Just Get An Extension.)

Consider our excellent GNM Virtual Tax compliance service for traders and general clients.

Tax Due Dates

*Jan. 17, 2017:
- Q4 2016 estimated taxes are due. Many traders omitted or underpaid Q1, Q2 and or Q3 2016 estimated tax vouchers since they thought they could lose money later in the year. Now is the time to catch up based on actual profit or loss. Don’t overlook the “prior year safe harbor” rule: You only have to cover 100% of 2015 taxes, 110% if AGI was over $150,000, with the balance of 2016 taxes payable April 18, 2017.

*Jan. 31, 2017:
- Jan. 30 is the end of the 30-day period for calculating wash sale loss deferrals on closed securities trades in 2016. Be diligent in Jan. to avoid wash sales, which can increase your 2016 capital gains income.
- Prepare, issue and e-file W-2s for employees, and Form 1099-Misc for vendors and independent contractors of your business. (Accelerated due date, NEW this year).
- Fund 401(k) retirement plan elective deferrals for Dec. 2016.

*Mar. 15, 2017:
- 2016 S-Corp tax returns or extensions are due.
- 2016 Partnership tax returns or extensions are due (NEW this year, it used to be April 15).
- 2016 S-Corp or partnership Form 7004 extension filings allow for 6-months additional time to file until Sep. 15, 2017.
- 2017 S-Corp Election Form 2553 is due for existing S-Corps. Most states accept the federal election, but a few do not. (Traders need an S-Corp to unlock employee benefit plan deductions, including health insurance and retirement.)
- 2017 Section 475 election is due for existing S-Corp or partnership trading companies with trader tax status. (If you have significant Q1 2017 trading losses, you should seriously consider this election, even if you have a capital loss carryover to use up.)
- 2017 Section 475 revocation election is due for existing S-Corp or partnership trading companies.

*April 18, 2017: (the 15th is on the weekend)
- 2016 Individual tax returns or extensions are due with tax payments.
- 2016 Individual Form 4868 extension filings allow for 6-months additional time to file until Oct. 17, 2017.
- 2017 Section 475 election is due for existing individual taxpayers with trader tax status. (If you have significant Q1 2017 trading losses, you should seriously consider this election, even if you have a capital loss carryover to use up. You can form an entity right afterward to get back to capital gains treatment.)
- 2017 Section 475 revocation election is due for existing individuals.
- 2016 Traditional or Roth IRA and Health Savings Account (HSA) contributions are due.

Get organized

- Download 2016 tax information documents in PDF format and upload them in a secure and encrypted manner to your tax compliance service provider.
- Fill out questionnaires and follow checklists from your CPA firm.
- Accounting: Use an accounting solution or service customized to your needs, and catch up with annual accounting for 2016. Your accounting system should generate revenue, income, capital gains and losses, business expenses, itemized deductions, and home-office expenses. For entities, it should also produce the balance sheet including assets, liabilities and equity. Proper accounting saves tax preparation time, and it ensures maximizing tax deductions.
- Accounting for securities trading: Active traders should consider the GNM trade accounting service, whether you use the realization or Section 475 MTM method. Download transactions from brokers.

Consider the GNM virtual process

You don’t have to be a trader to benefit from our web-based virtual tax service, available to U.S. residents around the U.S. and the world. Since 1997, clients and the media recognize GNM Virtual Tax as the leading CPA firm for traders. We earned their recognition for two reasons: Valuable “trader tax” ideas and clients appreciating our efficient virtual process, delivering excellent customer experience and service. Learn more about GNM Virtual Tax and our virtual process.

Resources for the 2017 tax season

- Green’s 2017 Trader Tax Guide available in paperback and PDF format.
- Webinars: GreenTraderTax Webinars scheduled for Interactive Brokers, Lightspeed Trading, and others during Q1 2017.
- Events: Robert Green CPA is presenting a Workshop “Trader Tax Law” at the Traders Expo New York City on Feb. 28, 2017, at 8:00 am ET. Meet Mr. Green at our kiosk in the Exhibit Hall.
- Website content: Visit our Trader Tax Center, blog archive, Webinar recordings, Tax Tools and other content on our Website.

We wish you a successful tax season.

Darren Neuschwander CPA and Adam Manning CPA contributed to this blog post. 


These Tax Errors Will Cost Professional Traders Dearly

August 10, 2016 | By: Robert A. Green, CPA

ForbesSmall

Read my blog post in Forbes.

Most active traders make serious errors on income tax returns, whether they self-prepare or engage a local accountant. Many miss out on trader tax benefits and overpay on their taxes. The cost ranges from $5,000 to hundreds of thousands of dollars.

When you shop for a tax preparer, ask about trader tax status, Section 475 elections, wash sale loss rules, and tax treatment for forex, options, Section 1256 contracts, ETFs, and ETNs. If they look like a deer caught in headlights, you’ll realize that your tax professional is not proficient enough for your needs. CPAs have a code of ethics requiring them to decline an engagement if they are not proficient, but local tax storefronts do not.

Here’s my 2016 list of tax reporting errors made by traders and accountants.

1. Mistakenly believing you can rely on securities Form 1099-B:

Most preparers rely on broker Form 1099-B for tax reporting. There’s a problem with wash sales. A wash sale loss is tax-deferred when you buy back a security position 30 days before or after making a sale at a loss.

Here’s the problem with wash sales reported on the 1099-B: IRS rules for brokers are simple, and most people do not realize that IRS rules for taxpayers are different and more complex. Tax preparers choose to play ignorant and import 1099-B, so it’s easy to reconcile Form 8949 with 1099-B. That means they are using broker rules and willfully disregarding Section 1091 rules for taxpayers. They should use trade accounting software that is compliant with taxpayer rules.

Broker rules base wash sales on identical positions, per account. Taxpayer rules base wash sales on substantially identical positions, across all accounts, including IRAs. A broker does not calculate a wash sale on Apple equity vs. Apple options because they are not identical symbols, but taxpayers must do so because they are substantially identical positions.

With education, traders can avoid wash sale losses. That is better than ignoring taxpayer rules and playing the audit lottery with the IRS.

2. Messing up Form 8949 cost-basis reporting:

The IRS requires reporting each securities trade on Form 8949 with the description, dates acquired and sold, proceeds, cost basis, code, adjustments, and gain or loss.

The primary adjustment is for wash sales. Other cost-basis adjustments include corporate actions (stock splits and reinvested dividends), inherited positions, gifts, and transfers from other accounts. Taxpayers often use incorrect amounts for these items.

There is one scenario where a taxpayer can solely rely on a 1099-B and skip filing Form 8949 by entering 1099-B amounts on Schedule D: when the taxpayer has only one brokerage account and trades equities only with no trading in equity options, which are substantially identical positions. Plus, the taxpayer must not have any wash sale loss or other adjustments.

However, if you trade options and equities, which are substantially identical positions, and/or you have multiple brokerage accounts, including IRAs, then you need trade accounting software that’s compliant with Section 1091 to generate Form 8949. Most software available through brokerage websites are not compliant with taxpayer rules in Section 1091. Download the original trade history from your broker’s website into a compliant program to generate Form 8949 or Form 4797 with Section 475.

3. Overlooking trader tax status or messing it up on Schedule C:

Most tax preparers and tax software do not offer resources about trader tax status (TTS) and related tax benefits. Other CPAs tell me they didn’t even realize their long-term clients had started a trading business. They thought trading was an investing activity using Section 212′s investment expense and the capital gains and loss treatment.

Overlooking qualifications for TTS can cost a trader $5,000 to $15,000 or more in tax benefits due to the preference of Section 162′s business expense treatment on Schedule C vs. Section 212′s restricted expense treatment on Schedule A.

Some accountants err in reporting trading income and losses on Schedule C. They should list trading business expenses only on Schedule C. Traders report trading gains and losses on different tax forms, including Form 8949 for securities, Form 6781 for Section 1256 contracts, and Form 4797 for Section 475 trades.

Traders should include well-written statements with their tax returns explaining TTS, how they qualify, tax treatments, and elections made. They should ask the IRS to view their trading business as a collection of tax forms. Otherwise, the IRS may see Schedule C as a losing business without any revenue. Most preparers do not include footnotes, and if they do, they tell the wrong story.

Don’t fall into the hobby loss or passive activity loss trap: Do not let a preparer or IRS agent subject your trading business to Section 183 hobby loss disallowance rules because it’s not recreational or personal in nature. A trading company is also exempt from Section 469′s passive activity loss rules by the Section 469 “trading rule.”

Recent trader tax court cases served up significant losses to traders. The IRS caught traders trying to deduct capital losses as ordinary losses. Net capital losses are limited to $3,000 per year on Schedule D, and excess capital losses should be carried over to subsequent tax year(s) on Schedule D. Ordinary loss treatment for trading losses is possible if a trader with TTS timely elects Section 475. In that case, report Section 475 trading losses on Form 4797 Part II, not on Schedule C.

A trader can claim TTS business expense treatment after-the-fact, and the IRS does not require an election. Preparers often conflate TTS with Section 475, but that’s a mistake. A trader with TTS has the option to elect Section 475, but many choose not to do so.

4. Overlooking or messing up a Section 475 election:

A trader qualifying for TTS may elect Section 475 MTM with ordinary gain or loss treatment. Report Section 475 trades on Form 4797 Part II, rather than on Form 8949.

The main tax benefits of Section 475 are an exemption from wash sale loss adjustments and capital loss limitations. Ordinary business losses offset income of any kind, and they are part of net operating loss (NOL) carrybacks and or carryforwards.

One of the biggest pitfalls for traders is messing up the decision-making with a Section 475 election. If you have existing capital losses from a capital loss carryover, year-to-date realized capital losses, and unrealized capital losses, you may want to retain capital gains treatment. That’s because Section 475 is ordinary income, which can’t absorb capital loss carryovers. On the other hand, you don’t want additional capital losses that are unutilized.

Preparers err in making a decision too early, not waiting until the election deadline, which offers some hindsight. They do not understand they can make alternative plans: You can revoke Section 475 in a subsequent tax year or form a new entity for a “do over” on electing Section 475, within 75 days of inception. You can choose Section 475 on securities only and retain lower 60/40 capital gains tax rates on Section 1256 contracts.

Many preparers miss the deadline for filing a Section 475 election statement and Form 3115 (Change in Accounting Method). Any misstep invites the IRS to disallow Section 475. Read recent trader tax court cases on my blog, including on Poppe, Assaderaghi, Nelson, and Endicott.

5. Messing up Form 4797 and overlooking a Section 481(a) adjustment:

Report each Section 475 transaction on Form 4797. Mark-to-market reporting means you must impute sales of open securities positions at year-end based on market prices.

The Section 475 election process includes a Section 481(a) adjustment to convert from the realization (cash) method to the MTM accounting method, as of Jan. 1 of the election year. That adjustment is the unrealized gain or loss on the prior year-end open trading business positions. Negative Section 481(a) adjustments are reportable in full, but positive ones over $50,000 must be pro-rated over four years. Many preparers overlook or err in making this adjustment, and others forget about reporting the deferral income in subsequent years. If you don’t qualify for TTS in the prior year, there is no Section 481(a) adjustment.

6. Commingling Section 475 trades with investment positions:

If you use Section 475 on your trading account and also make investments in a segregated investment account, be sure not to trade the same symbols between the two accounts, as that gives the IRS an opening to reject some Section 475 losses, or to disallow some long-term capital gains. Both will raise your tax bill. Section 475 regulations require careful segregation of investments from Section 475 trades in form and substance. Most preparers are unaware of these nuances in Section 475, and they misadvise clients about how to stay clear of this trouble.

7. Overlooking or messing up capital loss carryovers:

Some self-preparers mistakenly think they should only report a 3k capital loss carryover each year since they figure that is all they can use against other income. That is wrong: Report the entire capital loss carryover on Schedule D, short term vs. long term. It is okay to have a capital loss that carries over again to the next tax year.

Others overlook entering a capital loss carryover. Some figure not reporting them until they have capital gains to use them up. However, it can become too late, since the capital loss carryover year closes after three years. The IRS does not allow a capital loss carryover unless you report it on your prior year’s tax return, so don’t let a capital loss carryover lapse. Capital loss carryovers do not expire.

Capital losses are unlimited against capital gains. Deduct up to $3,000 of net capital losses against other income. It’s automatic, and not optional. For example, carry over $50,000 of capital losses and use it against $30,000 of current year capital gains, leaving a $20,000 net capital loss. Use the $3,000 capital loss limitation against other income and carry over $17,000 of the remaining capital loss to the subsequent tax year.

8. Overlooking the election to carry back a Section 1256 loss:

Many preparers do not know they can elect to carry back a Section 1256 loss. Check that box on top of Form 6781 to report current year net losses on Form 1040X amended tax returns for the prior three tax years, in order of oldest year first. The loss can only offset Form 6781 gains, not other income.

9. Using the wrong tax treatment on various financial instruments:

Many preparers do not realize that some financial instruments require ordinary gain or loss treatment or qualify for lower 60/40 capital gains tax rates in Section 1256. Many preparers incorrectly think that all trading instruments use the realization method with short-term and long-term capital gains rates.

It’s wise to double-check your broker’s 1099-B reporting. For example, a few foreign futures received Section 1256 treatment in IRS revenue rulings. Otherwise, without that ruling, they are treated as securities.

Forex trading is an ordinary gain or loss by default, but traders may elect to opt out of Section 988 into Section 1256(g) on “major currencies” only, which means the U.S. future exchanges list the same pairs. The U.S. brokers do not issue a 1099-B for spot forex transactions. A trader must file a Section 988 opt-out election on a contemporaneous basis in a taxpayer’s books and records. That means internally as opposed to filing it with the IRS. You can file the election for the whole year or part of the year. Many preparers mess up forex tax treatment, and IRS and state agents are confused over the reporting, too.

Securities ETFs are usually registered investment companies (RICs). Selling a Securities ETF is deemed a sale of security. Many preparers make errors with commodities/futures ETFs, which are publicly-traded partnerships (PTPs). PTPs issue annual Schedule K-1s passing through Section 1256 tax treatment on Section 1256 transactions to investors, as well as other taxable items. Selling a commodities ETF is deemed a sale of security, calling for short-term and long-term capital gains tax treatment. Taxpayers invested in commodities/futures ETFs should make adjustments to cost basis on Form 8949 to capital gains and losses, ensuring they don’t double count Schedule K-1 pass through income or loss. The broker 1099-B will not make this adjustment for you. Options on ETFs are securities whereas options on commodity ETFs can be Section 1256 contracts.

Gold ETFs use the publicly traded trust (PTT) structure, which the IRS considers a disregarded entity. In effect, it’s like directly owning gold bullion. Precious metals are “collectibles” with higher long-term capital gain rates up to 28%. Collectibles held one year, and less are short-term capital gains. Many preparers make errors reporting transactions in precious metals.

Exchange-traded notes (ETNs) are prepaid forward contracts, and tax treatment calls for the deferral of taxes until sale. Alternative tax treatment is unclear on ETNs.

10. Mishandling foreign transactions:

Many Americans trade financial products on global exchanges. Some trade through a U.S. broker who reports all sales globally on Form 1099-B. Most U.S. brokers keep accounts for foreign transactions in U.S. dollars.

It is complicated when traders open an offshore brokerage account held in a foreign currency. Counterparties outside the U.S. do not issue Form 1099-B, and accounting is a challenge. Separate capital gains and losses with embedded currency fluctuation from currency fluctuation on cash balances. Many preparers make mistakes double counting some currency appreciation or depreciation.

Some brokers outside the U.S. encourage Americans to form a foreign entity to set up an offshore brokerage account. Look before you leap: Tax compliance for foreign entities is significant, and there are few to no tax advantages for traders. International tax compliance is very complex and often nuanced, and it’s risky if you mess up tax reporting. Most preparers are not proficient in international tax compliance for U.S. residents.

For U.S. residents, foreign bank, brokerage, investment and other types of accounts — including retirement and insurance in some cases — must be e-filed on FinCEN Form 114, Report of Foreign Bank and Financial Account. If your foreign bank and financial institution accounts combined are under $10,000 for the entire tax year, you fall under the threshold for filing. If you do need to e-file FinCEN Form 114, the deadline is June 30 of the following year. Many preparers overlook FinCEN Form 114, and the penalties can be very high for willful non-compliance.

11. Overlooking or double counting home office deductions:

Most traders with TTS have a room in their home used for business, but they omit home office deductions since they think it’s a red flag with the IRS. The reverse it true: Without a home office or outside office, it does not look like you operate a business.

Some self-preparers double count real estate taxes and mortgage interest deductions on Schedule A. They do not realize Form 8829 allocates the non-business portion of those deductions to Schedule A.

Other preparers wind up with a carryover of home office expenses, with no current year deduction, because they did not point Form 8829 to trading gains or transfer some trading gains to Schedule C as explained in Green’s 2016 Trader Tax Guide. Form 8829 deductions require income; that’s how the IRS keeps a lid on this deduction. Traders without TTS may not deduct home office expenses.

12. Deducting education expenses when not allowed:

New traders often incur significant education costs before they begin trading in live accounts and qualify for TTS. Many preparers incorrectly deduct education as a Section 212 investment expense on Schedule A. However, pre-business education is not deductible in Section 212 by Section 274(h)(7).

Education incurred after business commencement is a business expense. Try to capitalize pre-business education as part of Section 195 startup costs, which can be expensed $5,000 when business commences, with the rest amortized over 15 years. Include a reasonable amount going back six months.

13. Paying self-employment tax when not owed:

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

The full SE tax (15.3%) applies to the social security base ($118,500 for 2016). The Medicare portion (2.9%) is unlimited.

14. Deducting employee benefit plans when not allowed:

Preparers compound the above error by having the trader contribute to a retirement plan based on net trading business income. A taxpayer may contribute to a retirement plan if he or she has SEI or wages, but trading gains are not SEI. In this case, the trader is deemed to have an “excessive contribution” subject to tax penalties.

Preparers also mistakenly take an AGI deduction for self-employed health insurance premiums, which requires SEI.

If a trader wants employee benefit plan deductions, including health insurance and a retirement plan, he or she should consider an S-Corp pass-through entity tax return. The S-Corp pays officer compensation to unlock these deductions. Many preparers overlook year-end tax planning, which includes payroll and Solo 401(k) plan execution.

Some preparers err in deducting employer-provided health insurance like COBRA. For health insurance to be AGI-deductible, the medical insurance must be an individual or group plan associated with the business. Many preparers err in not adding the health insurance premiums to the S-Corp officer compensation Form W-2, and it’s not subject to payroll tax.

Watch our video: These Tax Errors Will Cost Professional Traders Dearly.


Close