Category: Trader Tax

Wash Sale Losses for Traders: How to Avoid Phantom Income and Costly Tax Traps

September 10, 2026 | By: Robert A. Green, CPA

A practical 2026 guide to the 61-day window, cross-account reporting, IRA traps, year-end planning, and Section 475 MTM

This article is for active securities traders with frequent turnover, multiple brokerage accounts, options activity, or overlap between taxable and retirement accounts.

Executive Summary

Hyperactive trading in the same securities and related options can generate wash-sale loss adjustments totaling tens or hundreds of thousands of dollars—and sometimes more. Those adjustments can create phantom taxable income when losses remain deferred at year-end. In taxable accounts, the losses are usually deferred rather than lost; however, a replacement purchase in an IRA or Roth IRA can cause the tax benefit to be lost permanently.

Form 1099-B reports broker-level wash-sale adjustments generated throughout the year. Still, it does not determine the taxpayer’s complete wash-sale position or distinguish losses already absorbed in closed positions from losses still deferred in open replacement positions at year-end. Broker reporting follows limited rules, principally for covered securities with the same CUSIP in the same account. Taxpayer-level compliance may require a broader review of multiple taxable accounts, IRAs and Roth IRAs, options, short sales, and other substantially identical positions. Spouse or controlled-entity activity may also require analysis under related-party or anti-abuse principles, but it is not automatically attributed to the taxpayer under the text of Section 1091.

Active traders need multi-account, taxpayer-level trade accounting and year-end planning. GreenTraderTax and Green’s annual Trader Tax Guide use consistent practical positions to address areas where the law does not provide a complete mechanical test. Those positions are explained below.

The wash-sale adjustment reported in box 1g of Form 1099-B can be alarming. But the headline number is not the whole story.

Wash sale rules defer a tax loss rather than erase it. The deferred loss is added to the replacement position’s cost basis. It is usually deductible when the replacement position is sold in a transaction that does not trigger another wash sale. The most serious problems arise when losses remain deferred through year-end—or become permanently nondeductible because the replacement purchase is made in an IRA.

What Is a Wash Sale?

A wash sale occurs when a taxpayer sells stock or securities at a loss and, during the 61 days beginning 30 calendar days before the sale date and ending 30 calendar days after the sale date, acquires substantially identical stock or securities or enters into a contract or option to acquire them. IRC §1091(a). The rule is intended to prevent taxpayers from realizing a tax loss while quickly restoring substantially the same investment position.

The rule also applies when the taxpayer acquires substantially identical securities in a taxable exchange. Purchases of replacement shares in an IRA or a Roth IRA can also trigger the rule.

When the rule applies in a taxable account:

The current loss is disallowed.
The disallowed loss is added to the tax basis of the replacement position.
The holding period of the replacement position includes that of the position sold.
If only part of the position is replaced, the wash sale adjustment applies on a share-by-share basis to the matched quantity.

In a taxable-account wash sale, the loss is deferred rather than erased: the disallowed amount is added to the replacement position’s cost basis under IRC §1091(d), and the holding period of the position sold generally tacks onto the replacement position under IRC §1223(3). In practice, tax software applies the rules lot by lot.

A Simple Wash-Sale Example

A trader buys 100 shares for $10,000 and later sells them for $8,000, producing a $2,000 loss. Ten days later, the trader buys 100 substantially identical shares for $8,500.

The $2,000 loss is deferred and added to the replacement shares’ $8,500 purchase price, producing an adjusted tax basis of $10,500. If the trader later sells the replacement shares for $9,500 without another replacement purchase within the wash sale window, the deferred loss is released through the higher basis, resulting in a $1,000 tax loss. The replacement trade produced a $1,000 economic gain, but the higher wash-sale-adjusted basis caused the trader to recognize the correct $1,000 net tax loss across both trades.

Wash sale losses in taxable accounts are therefore usually a timing problem rather than a permanent elimination of the deduction. Repeated trading can keep moving the loss from one replacement position to the next, creating a chain that crosses December 31 and shifts the deduction into the following year. A replacement purchase in an IRA or Roth IRA can produce a different—and potentially permanent—result.

Why Form 1099-B May Not Tell the Full Story

Broker reporting is narrower than the taxpayer’s legal obligation. The IRS Form 1099-B instructions require a broker to report a wash sale when both the loss sale and replacement purchase occur in the same account for covered securities with the same CUSIP. A broker may report more, but it is generally not required to identify a replacement purchase in another account—even in another account at the same brokerage firm.

That difference creates two common problems:

Form 1099-B may omit taxpayer-level wash sales involving another brokerage account, an IRA or Roth IRA, stock and related options, different option contracts, or other substantially identical positions.
A broker’s aggregate wash-sale adjustments for the year may be large even though most of those losses were absorbed into replacement positions that were sold before year-end.

For example, a broker’s Form 1099-B might report aggregate box 1g wash-sale adjustments of $500,000 for the year. That does not automatically mean $500,000 is deferred into next year. If the trader closed the replacement positions and avoided another acquisition during the applicable wash-sale window, little or none of that amount may remain deferred at year-end. Conversely, a smaller cross-account wash sale omitted from Form 1099-B may still require a taxpayer-level adjustment.

Even if a trader sells securities in December, a January purchase can still trigger a wash sale. Avoid acquiring substantially identical property within 30 days after the loss sale; the trader may reenter on day 31.

Consider using TradeLog for taxpayer-level wash-sale calculations. It imports transactions from multiple brokerage accounts, recalculates wash sales across those accounts, and helps reconcile the results with Forms 1099-B. Importing Forms 1099-B into tax software without this broader reconciliation is a much narrower approach and can leave material wash-sale adjustments unreported.

The IRA Wash-Sale Trap Can Make the Loss Permanent

The harshest wash-sale result occurs when an individual sells stock or securities at a loss in a taxable account and, during the 61-day window, an IRA or Roth IRA acquires substantially identical stock or securities. Under Revenue Ruling 2008-5, the taxable-account loss is disallowed, and the individual’s basis in the IRA or Roth IRA is not increased under Section 1091(d). Unlike an ordinary taxable-account wash sale, the tax benefit can therefore be lost permanently.

An IRA does not report wash sales on trades occurring solely inside the retirement account because its gains and losses are not currently taxable. The danger is the interaction between the taxable loss sale and the IRA or Roth IRA replacement purchase. Revenue Ruling 2008-5 addresses IRAs and Roth IRAs; it does not decide the treatment of employer-sponsored plans such as 401(k) or Solo 401(k) plans. The ruling also does not mention other types of IRAs such as rollover IRAs and SEP IRAs.

A practical safeguard is to maintain a do-not-trade list separating securities traded in taxable accounts from positions held in IRAs and Roth IRAs. A trader might trade individual technology stocks in taxable accounts and hold diversified funds in an IRA, provided the positions are not substantially identical.

Section 475 can provide another solution for a trader who qualifies for trader tax status (TTS). For securities properly included in a valid Section 475(f) trading business, Section 1091 does not apply to losses recognized under the mark-to-market rules. The election does not cover properly identified investment securities, and traders should not assume it resolves every transaction involving an IRA or another related account. A separate trading entity with a timely Section 475 election can also help segregate business trading from investment and retirement holdings.

Stocks, Options, ETFs, and Substantially Identical Positions

Section 1091 applies when a taxpayer acquires substantially identical stock or securities, or enters into a contract or option to acquire them, during the wash-sale window. The Code does not provide a complete mechanical test for deciding when different funds or option contracts are substantially identical.

The technical standard. Different ETFs or mutual funds are not automatically outside Section 1091 merely because they have different tickers, CUSIPs, or sponsors. Two unleveraged ETFs tracking the same S&P 500 index can present a substantially identical risk. The legal conclusion depends on the relevant facts and circumstances, including portfolio composition, index methodology, leverage or inverse exposure, investment objective, issuer rights, and other material economic characteristics.

Consider a conservative approach by treating ETFs tracking the same stock index — such as State Street SPDR S&P 500 ETF Trust (SPY) and Vanguard S&P 500 ETF (VOO) — as substantially identical for purposes of wash-sale loss treatment. On the other hand, SPY and VOO have different legal structures, which can support a formal position that they are not substantially identical.

Options on the same underlying security raise a similar interpretive issue when their strikes, expirations, exercise terms, or contract types differ. An exact replacement of the same option contract is the clearest case. Stock-to-option, option-to-stock, and different-option replacements may require analysis of the rights, risks, and economic exposure created by the positions. Cash settlement alone does not remove a contract or option from Section 1091. Section 1091(a), (f). The conservative posture is to treat all option contracts on the same underlying stock as subject to wash sale rules.

The practical positions used for trade accounting. Active traders and preparers need consistent, administrable conventions. GreenTraderTax and Green’s annual Trader Tax Guide apply the following practical positions during the year, unless particular facts require separate treatment, paired with a more conservative safeguard specifically at year-end:

• Different index funds: For ongoing trade accounting during the year, different ETFs or mutual funds are not treated as substantially identical merely because they track the same or a similar stock index — two different S&P 500 ETFs are treated as different securities. This is an aggressive position because the IRS has not provided an explicit safe harbor for same-index funds. As a year-end safeguard, revert to the more conservative technical standard described above for any positions still open across December 31: treat same-index ETFs as substantially identical, and avoid opening a replacement position in the other same-index ETF during the wash-sale window. That protects against a later challenge that the two funds were, in fact, substantially identical.

• Stock and options: Stock and all options on the same underlying security are treated as substantially identical without requiring the strike price, expiration date, or other option terms to match. This is a conservative position and may produce more wash-sale adjustments than a contract-by-contract analysis.

These are longstanding practical accounting positions, not a change in trade-accounting methodology. They resolve uncertain areas consistently; they do not mean that Section 1091 expressly mandates either convention in every factual setting. They also go substantially further than accepting an imported Form 1099-B as complete.

Qualifying Section 1256 contracts follow their own mark-to-market and 60-percent-long-term/40-percent-short-term rules and generally are not handled under the ordinary stock-and-securities wash-sale framework. Securities futures and other derivatives require separate analysis. Section 1091(e) also contains rules for certain short-sale and securities-futures losses. Traders should separately consider the straddle, constructive-sale, and other anti-abuse rules when positions offset one another.

Do Wash-Sale Rules Apply to Cryptocurrency?

Under current federal tax law, directly held ordinary spot digital assets, such as bitcoin, are generally treated as property rather than stock or securities, so Section 1091 ordinarily does not apply. The result may differ depending on whether the asset is an ETF, a trust interest, a tokenized security, a partnership interest, a derivative, or another legal wrapper. Traders should verify current legislation before relying on crypto tax-loss harvesting strategies.

Our legal-wrapper series, scheduled for publication beginning in October 2026, will address bitcoin ETFs and other wrapped financial products in detail.

How Traders Can Break the Wash-Sale Chain at Year-End

Waiting for a February Form 1099-B is too late to prevent a wash-sale loss. Traders should review potential wash-sale deferrals before year-end and coordinate activity across all relevant accounts.

A December loss sale can still produce a wash sale if the trader acquires substantially identical positions during the following 30 days in January.

A practical year-end process includes:

Use TradeLog, the trade-accounting software we recommend for taxpayer-level wash-sale calculations across multiple brokerage accounts. Run its Potential Wash Sales Report in November and again in December so there is time to plan loss sales and avoid replacement trades in January.
Identify securities carrying the largest deferred losses and the replacement tax lots holding those losses.
Sell open replacement positions before year-end to potentially release deferred wash-sale losses, and do not reacquire substantially identical property during the applicable restricted period.
Review and, where appropriate, pause purchases in relevant taxable accounts, IRAs, and Roth IRAs during the restricted period. Include automatic purchases and option activity. Review spouse, controlled-entity, and employer-plan activity separately when related-party or anti-abuse concerns may be present.
Reconcile the year-end carryover by ticker and tax lot so the deferred basis is tracked correctly into the next year.

For example, if a trader sells Apple shares at a loss on December 20, 2026, the trader should avoid Apple shares and substantially identical Apple positions through January 19, 2027, and may reenter on January 20, 2027.

A trader does not need to stop all trading. Under the practical position described above, the trader may switch from one tech stock (Apple) to another tech stock (Google) during the restricted period.

Section 475 MTM Can Eliminate Wash-Sale Accounting for Qualified Traders

Trader tax status (TTS) by itself does not eliminate wash-sale accounting. Section 1091(a) contains an exception for a dealer in stock or securities when the loss arises in the ordinary course of the dealer’s business, but ordinary trader status is not dealer status.

Section 475 is available to a taxpayer who qualifies for TTS and makes a valid, timely Section 475(f) mark-to-market election for the securities trading business. For covered business securities, Section 475 marks open positions to market at year-end, generally treats the resulting gains and losses as ordinary, and provides that Section 1091 does not apply to losses recognized under the mark-to-market rules. The $3,000 capital-loss limitation also does not apply to those ordinary business losses. Sections 475(d)(1), 475(d)(3), and 475(f).

Section 475 is not automatic and cannot ordinarily be elected retroactively after losses occur. It does not cover properly identified investment securities. The taxpayer must make a timely election and comply with the accounting-method-change requirements, including the filing of Form 3115 when applicable. Sole proprietors generally elect by the unextended due date of the prior-year individual return; partnerships and S corporations use the unextended due date of the prior-year entity return. A new entity has a separate internal election procedure within two months and 15 days of inception.

For most calendar-year individuals, the deadline to make a 2026 Section 475(f) election passed on the unextended due date for the 2025 individual return, April 15, 2026. A trader considering Section 475 after that deadline generally is evaluating an election for the following tax year, subject to the applicable rules.

For an active securities trader who qualifies for TTS, Section 475 can provide valuable tax-loss insurance and cleaner accounting. The decision should be made before the election deadline.

Coming soon in this wash-sale series: “How TTS Traders Report Section 475 MTM Gains and Losses on Form 4797,” covering the election, accounting-method change, segregation rules, and return preparation.

Reporting Wash Sales on Form 8949

For a detailed walkthrough of Form 8949 reconciliation, adjustment codes B and M, substitute statements, and Form 8453 filing requirements, see Part 2 of this series: ‘Wash-Sale Accounting: Why Broker Form 1099-B Reporting Is Not Taxpayer Compliance.

Coming in October: Our Legal Wrapper Series

Beginning in October 2026, we plan to publish our legal wrapper series explaining why the term “security” can have different meanings under different tax provisions. Section 475 MTM uses a broader definition for TTS traders, while Section 1091 wash sales uses a narrower one. As a result, an underlying instrument might fall outside Section 1091, while an ETF, option, or other wrapper referencing that instrument might itself be treated as stock or a security under Section 475.

Bottom Line

Wash-sale losses are manageable when traders monitor them during the year, but they become expensive when ignored until tax season. The biggest risks are not the gross annual adjustment in box 1g. They are losses deferred after December 31, unreported cross-account wash sales, permanent losses caused by IRA or Roth IRA replacement purchases, and incorrect basis carried into future years.

Active securities traders should use multi-account trade accounting, coordinate taxable and retirement-account activity, and plan early enough to break the year-end chain. The longstanding practical positions used by GreenTraderTax and Green’s annual Trader Tax Guide provide a workable and consistent method for uncertain ETF and option relationships. Traders who qualify for TTS should also evaluate a timely Section 475 election for the next tax year. TTS traders under Section 475 avoid the confusion and complexity of wash sale losses in their trading activity.

Sources and Further Reading

IRC Sections 1091 and 475; Treasury Regulation Sections 1.1091-1, 1.1091-2, and 1.6045-1; Revenue Ruling 2008-5; IRS Instructions for Form 1099-B (2026); IRS Instructions for Form 8949 (2026); and IRS Publication 550 (2026).

This article is for educational purposes and does not constitute tax advice.

Trader Tax Forms and Compliance: How to Report Securities, Futures, Forex, and Crypto

August 17, 2026 | By: Robert A. Green, CPA

Traders don’t report all their activity on one tax form. The correct reporting depends on the financial product, whether the taxpayer qualifies for trader tax status (TTS), whether the position belongs to a trading business or an investment portfolio, and whether elections such as Section 475 mark-to-market (MTM) or a Section 988 opt-out apply.

That complexity can lead to incorrect tax returns and IRS notices. Business expenses may appear on Schedule C, securities trades on Form 8949 and Schedule D, Section 475 ordinary gains and losses on Form 4797, futures on Form 6781, and digital-asset transactions on Form 8949.

Broker tax forms are only a starting point. Traders remain responsible for applying the correct taxpayer-level rules, elections, and accounting methods.

Which tax forms do traders use?

Sole-proprietor TTS business expenses: Schedule C
Securities without Section 475: Form 8949 and Schedule D
Securities with Section 475: Form 4797, Part II
Section 1256 contracts: Form 6781
Spot forex under Section 988: Schedule 1 or Form 4797
Cryptocurrencies and digital assets: Form 8949 and Schedule D
Trading partnerships: Form 1065 and Schedule K-1
Trading S corporations: Form 1120-S and Schedule K-1

TTS business expenses go on Schedule C

Most sole-proprietorship businesses report revenue and expenses on Schedule C. A sole-proprietor trader qualifying for TTS, however, reports only trading-business expenses on Schedule C. Trading gains and losses go on other tax forms.

Trading gains and losses generally are not self-employment income merely because the taxpayer qualifies for TTS.

This unusual reporting can confuse the IRS. A TTS trader’s Schedule C may show expenses but no revenue, while trading gains and losses appear on Form 8949, Schedule D, Form 4797, or Form 6781. The IRS may view the Schedule C activity as an unprofitable business even when trading gains exceed business expenses.

We recommend including tax-return footnotes explaining TTS qualification and why trading gains and losses are reported separately.

Securities without Section 475 use Form 8949 and Schedule D

Securities traders who have not elected Section 475 generally report securities sales on Form 8949, which feeds into Schedule D. In most individual cases, reporting is transaction by transaction unless an exception or permitted attachment method in the Form 8949 instructions applies.

These transactions receive capital gain-or-loss treatment. Capital losses are limited to $3,000 per year against ordinary income, with the balance carried forward. Capital losses are unlimited against capital gains. Wash-sale loss rules also apply.

The taxpayer is responsible for wash-sale reporting

Brokers generally calculate wash sales based on identical positions within a single brokerage account. Taxpayers must consider substantially identical positions across all their accounts, including joint accounts, spousal accounts, and IRAs.

A trader may be able to rely more confidently on Form 1099-B in a narrow situation involving one brokerage account, equities only, and no trading activity in IRAs. Other traders may need tax-compliant trade-accounting software or professional assistance.

Wash sale loss rules are complicated for active securities traders, so see our upcoming blog post series on wash sales.

Partnerships and S corporations may summarize Form 8949

Partnerships and S corporations may qualify for summary reporting under a special entity provision in the Form 8949 instructions.

Generally, an entity filing Form 1065 or Form 1120-S with more than five transactions in the applicable part of Form 8949 may report combined totals using “Available upon request” in column (a) and code M in column (f), without attaching every transaction.

This reporting privilege comes from the Form 8949 entity rule—not from TTS. The entity must maintain complete transaction-level records, properly calculate wash-sale losses and other adjustments, and make its records available if requested.

Section 475 securities use Form 4797

TTS traders who timely elect and use Section 475 MTM for securities report their covered business trading gains and losses as ordinary gains or losses on Form 4797, Part II.

Section 475 requires open covered business positions to be marked to market at year-end. It also avoids the $3,000 capital-loss limitation and wash-sale loss rules for those positions.

Section 475 is not automatic merely because a trader qualifies for TTS. TTS is determined based on the taxpayer’s trading activity. Section 475 requires a timely election and, for an existing taxpayer, an accounting-method change, when required, using Form 3115. Late Section 475 elections generally are not allowed.

Form 4797 requires transaction details

Form 4797 shows summary amounts, but the Form 4797 instructions require an attached statement in the same format as line 10 detailing each transaction. Securities or commodities held and marked to market at year-end must be separately identified. Enter “Trader—see attached” in column (a) of line 10 and report the totals from the statement in columns (d), (f), and (g).

Segregate investment positions

Section 475 applies to covered business trading positions, not to properly identified investments.

Investment positions should be segregated from the trading business and clearly identified in the trader’s records before the close of the day they are acquired, originated, or entered into. The identification should establish that the position is unrelated to the trading business.

Properly segregated investments retain capital gain-or-loss treatment and remain reportable on Form 8949 and Schedule D.

A Section 475 trader or entity may therefore use both reporting methods:

Section 475 business trades go on Form 4797 with the required transaction-detail statement.
Properly identified investments go on Form 8949 and Schedule D.
Investments held by a qualifying partnership or S corporation may be eligible for the Form 8949 entity summary-reporting rule.

Section 1256 contracts use Form 6781

Section 1256 contract traders—including many futures traders—report their aggregate annual gain or loss on Form 6781, Part I.

These contracts generally receive 60/40 capital-gains treatment: 60% is treated as a long-term capital gain or loss, and 40% is treated as a short-term capital gain or loss, regardless of the holding period. Open contracts are marked to market at year-end, and wash-sale rules do not apply.

Section 1256 traders generally do not use Form 8949 for these contracts. They typically rely on Form 1099-B showing the aggregate profit or loss on contracts.

Many futures traders do not elect Section 475 for commodities because they prefer Section 1256’s 60/40 capital-gains treatment. Traders who properly elect Section 475 for commodities or futures report covered business trading gains and losses on Form 4797 instead.

Section 1256 loss carrybacks

An eligible individual with a qualifying net Section 1256 loss may elect to carry it back three tax years, applying it only against net Section 1256 gains in those years.

Make the election by checking box D, “Net section 1256 contracts loss election,” and entering the carryback amount on Form 6781. An eligible individual generally claims the carryback using Form 1045 or Form 1040-X, with amended Forms 6781 and Schedules D for the applicable years.

Corporations, estates, and trusts cannot make this carryback election. Partnerships and S corporations generally pass Section 1256 gains and losses through to their owners. The carryback election, if available, is made on the eligible individual owner’s return.

Forex reporting depends on the contract and elections

Forex tax treatment depends on the instrument, the default Section 988 rules, and whether the trader made a contemporaneous opt-out election.

Spot forex transactions receiving ordinary gain-or-loss treatment under Section 988 are generally reported on Schedule 1 for investors and Form 4797, Part II, for TTS traders.

Currency futures and certain major currency contracts may fall under Section 1256 and Form 6781. Capital gains and losses reporting may apply when a trader makes a contemporaneous election to opt out of Section 988. Forex generally uses summary reporting.

Large Section 988 losses may require Form 8886

A gross Section 988 foreign-currency loss of at least $50,000 in a single tax year for an individual or trust may be a reportable loss transaction requiring Form 8886, Reportable Transaction Disclosure Statement. This threshold can also apply when the loss passes through from a partnership or S corporation.

Because penalties for missing a required Form 8886 can be significant, traders with large forex losses should review the reportable-transaction rules before filing.

Digital assets bring new Form 1099-DA reporting

Sales and exchanges of cryptocurrencies and other digital assets generally are reported on Form 8949 and Schedule D.

Brokers began using Form 1099-DA to report gross proceeds from digital-asset sales effected during 2025. For 2025 sales, brokers were generally not required to report the cost basis.

For sales after 2025, brokers generally must report basis for covered digital assets acquired after 2025. Basis reporting for noncovered digital assets generally remains voluntary.

Form 1099-DA does not relieve the taxpayer of responsibility for determining the correct basis, holding period, gain or loss, and for reporting on Form 8949. Traders should reconcile Forms 1099-DA with their own digital-asset records.

Current federal wash-sale rules generally do not apply to spot cryptocurrency because it is not treated as stock or securities for this purpose. Tokenized instruments or digital-asset products that are themselves stocks, securities, or security-based derivatives require separate analysis.

Section 475 ordinarily does not apply to spot cryptocurrency itself. The IRS has not issued definitive guidance on whether cryptocurrency qualifies as a ‘commodity’ eligible for a trader’s mark-to-market election under Section 475(e) or (f), so this remains a developing area. See our blog post series on digital assets at https://greentradertax.com/category/cryptocurrencies/.

Broker forms are not always the final tax answer

Forms 1099-B and 1099-DA are important starting points, but brokers issue them under broker-reporting rules. They do not know all the taxpayer’s accounts, tax elections, TTS position, investment identifications, or other relevant facts.

Traders should reconcile broker reports with:

Tax-lot accounting records
Taxpayer-level wash-sale calculations
Section 475 elections and year-end MTM adjustments
Section 988 elections
Digital-asset basis and holding-period records
Properly segregated investment positions

Entity returns can provide cleaner reporting

A trading partnership files Form 1065, while a trading S corporation files Form 1120-S. Each entity issues Schedule K-1s to its owners.

Entity returns consolidate trading gains, losses, and business expenses into a single return. Portfolio income, capital gains and losses, Section 475 ordinary gains and losses, and business expenses retain their applicable tax character when passed through.

An entity is not a substitute for TTS. The trading activity conducted within the entity must independently qualify as a trading business. Forming an entity does not convert investment activity into a TTS business.

Section 475 election procedures are strict

Section 475 does not have a stand-alone IRS election form.

An existing taxpayer generally makes a Section 475 election by the original due date—without extensions—of the prior-year return. Attach the election statement to the return if filed by that date or to a timely extension request. The taxpayer later perfects the accounting-method change by filing Form 3115 with the election-year return when required.

An existing taxpayer changing from the realization method to Section 475 generally must calculate a Section 481(a) adjustment as of the first day of the election year. The adjustment accounts for unrealized gains and losses on open covered business securities positions held at the end of the preceding year.

A newly formed entity that is a new taxpayer generally adopts Section 475 internally in its books and records within two months and 15 days after the beginning of its election year—often described as within 75 days of inception. A new taxpayer adopting Section 475 from inception generally does not file Form 3115 because it is not changing from a previous accounting method.

Traders should retain reliable, date-stamped proof of timely elections.

Section 475 revocations can be difficult

Under current IRS procedures, revoking a Section 475 election within five tax years of making it generally requires a non-automatic accounting-method change, IRS consent, and payment of the applicable user fee.

Traders should consider the potential difficulty and cost of revocation before making the election.

Alternatively, if a trader actually ceases to qualify for TTS, Section 475 is suspended during the nonqualification period without a formal revocation. If the trader later requalifies for TTS, the existing Section 475 election generally applies again. This is not an elective switch: the suspension must be supported by a material change in the taxpayer’s trading activity and facts.

Common IRS notice triggers

Common compliance and IRS-notice issues for traders include:

Schedule C showing business expenses but no trading revenue, which looks like a losing business
Schedule C improperly showing trading gains and losses
Form 8949 differing from Form 1099-B because taxpayer wash-sale rules differ from broker rules
Digital-asset proceeds on Form 1099-DA that are not reconciled with Form 8949
Missing Form 4797 transaction-detail statements
Section 475 ordinary losses reported without a timely election
Large Section 988 losses filed without reviewing the Form 8886 requirement
Failure to identify and segregate investments from a Section 475 trading business

Include tax-return footnotes

We recommend that business traders include tax-return footnotes explaining:

How the taxpayer qualifies for TTS
Whether the taxpayer timely elected Section 475
Whether the taxpayer elected to opt out of Section 988
How investment positions were identified and segregated
Why Form 8949 differs from Forms 1099-B or 1099-DA
How taxpayer-level wash-sale adjustments were calculated
Any other significant tax-treatment or reporting positions

Well-prepared footnotes can address potential IRS questions before they result in a notice or examination.

The bottom line

Traders do not use one universal tax form. Product type, TTS qualification, tax-treatment elections, accounting methods, and entity structure determine the reporting path.

Mistakes involving Section 475 elections, wash-sale calculations, investment segregation, or missing disclosures can be costly. Traders should address these issues before tax preparation begins and retain detailed records supporting their reporting positions.

For more information, see Green’s Trader Tax Guide. See Chapter 6, “Trader Tax Return Reporting Strategies.”

Tax laws and reporting rules change, and these strategies may not fit every trader. Consult a qualified tax professional regarding your facts.

The Most Important Trader Tax Court Cases Every Active Trader Should Know

July 4, 2026 | By: Robert A. Green, CPA

Reference article for active traders who want a practical roadmap to the leading trader-tax cases. Trader Tax Status is only one part of trader-tax law. Tax Court decisions also address Section 475 elections, mark-to-market accounting, documentation and attribution issues, and the line between traders, investors, and dealers. This article is intended as a practical roadmap to the principal trader-tax cases, not a comprehensive legal digest. See Trader Tax Status for the related tax benefits.

Bottom line

There is no minimum trade count in the tax law for Trader Tax Status. Courts apply a facts-and-circumstances analysis. GreenTraderTax uses approximately 720 total trades per year — counting buys and sells separately — as a practical planning benchmark based primarily on Poppe v. Commissioner, T.C. Memo. 2015-205. That figure is a planning benchmark, not a legal threshold.

Why this companion article matters

Most traders do not need a long legal digest. They need a clear reference piece that:

identifies the trader-tax cases that matter most,
separates practical planning benchmarks from legal authority, and
shows where TTS analysis ends, and Section 475 compliance begins.

Compliance note

Many trader-tax court cases are cautionary stories. The problem is often not one bad fact, but a combination of weak trading activity, poor documentation, missed or defective Section 475 elections, and inadequate representation during IRS exams or appeals. The best strategy is to claim TTS only when the facts support it and to follow Section 475 election procedures exactly.

Quick answers for active traders

Is there a minimum trade count for TTS?

No. Courts weigh volume, frequency, continuity, holding periods, and short-term trading intent.

Is 720 trades per year a legal threshold?

No. It is GreenTraderTax’s planning benchmark based primarily on Poppe.

Is Section 475 the same as TTS?

No. TTS depends on activity. Section 475 requires a separate, valid, timely election by the correct taxpayer.

Only traders eligible for TTS can elect and use Section 475 MTM accounting. TTS and Section 475 are critical issues in many IRS exams and in tax court cases involving traders. In many cases, taxpayers deducted significant ordinary losses they were not entitled to deduct because they either did not qualify for TTS, a prerequisite to using Section 475, or failed to properly elect Section 475.

For existing taxpayers, Section 475 generally involves two steps. First, file a Section 475 election statement for the current year with the prior-year tax return or timely extension by the applicable deadline. Second, perfect the election by filing Form 3115, Change in Accounting Method, with the current-year tax return. A copy of Form 3115 must also be filed with the IRS National Office in Ogden, Utah, at the same time the tax return is filed.

If you miss the applicable election requirements, you generally cannot use Section 475 ordinary gain-or-loss treatment for that year. See more information on how a new entity can make an internal resolution under Section 475 in the checklist below.

GreenTraderTax Planning Benchmarks

GreenTraderTax uses approximately 720 total trades per year, counting buys and sells separately, as a practical benchmark. Courts also focus on how trades are spread through the year, holding periods, trading days, frequency, business intent, time spent per day, sporadic lapses, operations, account size, and whether the strategy seeks short-term market swings rather than long-term appreciation. See Trader Tax Status: How to Qualify for a fuller discussion of all TTS factors.

GreenTraderTax also considers continuous business activity (CBA) when evaluating close cases. CBA may help support TTS when transaction frequency is a little short, but it is not a replacement for the core benchmarks of trade volume, frequency, trading days, and average holding period.

TTS foundation cases

Case	Main issue	Practical point
Liang v. Commissioner, 23 T.C. 1040 (1955)	Whether the taxpayer’s securities activity rose to the level of a trade or business rather than investing	Early foundation case: traders seek to profit from short-term market swings, not long-term appreciation
King v. Commissioner, 89 T.C. 445 (1987)	Whether trading activity was substantial enough to be a trade or business	TTS depends on substantial activity and business-like trading, not investor behavior
Mayer v. Commissioner, T.C. Memo. 1994-209	Whether the taxpayer’s activity was frequent, regular, and continuous	Courts look at the full trading pattern, not labels or intent alone
Hart v. Commissioner, T.C. Memo. 1997-11	Whether the taxpayer’s activity was continuous and business-like	Sporadic or limited activity weakens TTS
Kay v. Commissioner, T.C. Memo. 2011-159	Whether holding periods and trading pattern supported trader status	Longer holding periods and investment-like patterns weigh against TTS

Key benchmark and caution cases

Case	Main issue	Practical point
Poppe v. Commissioner, T.C. Memo. 2015-205	Whether the taxpayer qualified for TTS, and separately whether he made a valid §475 election	Best practical benchmark case for TTS: about 720 trades per year, regular activity, and substantial time commitment supported TTS; strong TTS facts do not cure a defective §475 election — Rev. Proc. 99-17/Form 3115 compliance matters
Assaderaghi v. Commissioner, T.C. Memo. 2014-33	Whether 535 trades were enough to constitute a trade or business	Trade count alone is not enough; pattern, continuity, and regularity matter more than raw totals
Nelson v. Commissioner, T.C. Memo. 2013-259	Whether the taxpayer’s activity was substantial and continuous enough for TTS	Useful for the distinction between volume and substance; active trading still fails if the overall activity lacks sufficient business character
Endicott v. Commissioner, T.C. Memo. 2013-199	Whether options trading with longer holding periods qualified for TTS	Holding periods of roughly 1 to 5 months were weighed against the trader status; the IRS argued that the taxpayer’s 35-day average holding period was too long.
Holsinger v. Commissioner, T.C. Memo. 2008-191	Whether the taxpayer was trading for short-term swings or investing	Longer holding periods and investment-like behavior weaken TTS
Crissey v. Commissioner, T.C. Summary Opinion 2017-44	Whether an active day trader with more than 500 trades qualified for TTS	Favorable day-trader fact pattern, but nonprecedential; not authority for a 500-trade minimum
Obayagbona v. Commissioner, T.C. Summary Opinion 2016-72	Whether trader facts could overcome failure to make a proper §475 election	Summary Opinion / nonprecedential: trader facts do not cure an election defect; valid, timely election required

Section 475 election and mechanics cases

Case	Main issue	Practical point
Chen v. Commissioner, T.C. Memo. 2004-132	Whether the taxpayer properly made a §475(f) election	Election mechanics matter; taxpayers must follow procedural rules exactly
Knish v. Commissioner, T.C. Memo. 2006-268	Whether the taxpayer was entitled to §475 treatment without proper compliance	No proper election, no §475 treatment
Arberg v. Commissioner, T.C. Memo. 2007-244	Whether trading activity conducted through an account could support the claimed §475 treatment	Ownership, attribution, and account structure matter; the correct taxpayer and correct records are critical
GWA, LLC v. Commissioner, T.C. Memo. 2025-34	Whether a selective or mismatched §475 election was valid in a partnership / basket-option / disregarded-entity setting	Narrower than many summaries suggest: the correct taxpayer must make the election; §475 cannot be selectively applied to only part of a securities-trading business

The six featured cases

1. Poppe — the best practical benchmark case

Poppe v. Commissioner, T.C. Memo. 2015-205 remains the clearest modern case for GreenTraderTax’s trade-count benchmark.

The Tax Court described approximately 60 trades each month, or roughly 720 trades during the year, and found the taxpayer’s activity sufficiently frequent, regular, and continuous to constitute a trade or business.

Poppe was not a complete taxpayer win, however. Although the court found a qualifying trader fact pattern for TTS purposes, it rejected the taxpayer’s claimed Section 475 treatment because he failed to prove a valid prior election under Rev. Proc. 99-17, including an executed Form 3115 and proof it was timely filed or mailed. The court also rejected the taxpayer’s substantial-compliance argument.

Practical takeaway

Poppe supports using roughly 720 total trades per year as a planning benchmark, but it also reinforces that TTS and Section 475 are separate issues.

2. Crissey — helpful, but not a 500-trade rule

Crissey v. Commissioner, T.C. Summary Opinion 2017-44 is often cited because the taxpayer reportedly made more than 500 trades and prevailed.

That makes Crissey attractive to traders looking for a lower numerical benchmark, but it must be used carefully:

it is a Summary Opinion,
Summary Opinions are nonprecedential, and
the opinion does not clearly state whether the trade count refers to executions, sales, or round trips.

Based on the reported trading period, it appears the taxpayer’s active trading may have begun partway through the year, implying a monthly pace of 50 or more trades. That is an inference from the facts, not a stated holding.

Practical takeaway

Crissey supports a favorable day-trader fact pattern. It does not establish a 500-trade threshold.

3. Assaderaghi — pattern matters more than totals

Assaderaghi v. Commissioner, T.C. Memo. 2014-33 shows why trade count alone is not enough.

Although the taxpayer made 535 trades, the court found the activity too irregular and not sufficiently continuous. The court also noted the taxpayer’s full-time engineering job, the lack of persuasive evidence regarding many of the holding periods, and that the activity was not sufficiently substantial overall to constitute a trading business.

Pattern Matters More Than Totals

Assaderaghi is the cautionary case for traders who focus only on annual trade count. A respectable total does not carry the day if the trading is clustered, continuity is weak, holding periods are not demonstrated, or the taxpayer’s overall activity does not appear to be a real trading business.

Practical takeaway

A trader with steady year-round activity has a stronger TTS fact pattern than a trader with a similar annual total concentrated into short bursts.

4. Nelson — substantiality and continuity still control

Nelson v. Commissioner, T.C. Memo. 2013-259 is better understood as a substantiality-and-continuity case than a pure documentation case.

The court focused on limited trading days, significant gaps in activity, and the taxpayer’s full-time nontrading work. Although the opinion also noted uncertainty about which trades were attributable to the taxpayer, the court made clear that she would lose even assuming all trades were hers.

Nelson also helps illustrate the difference between volume and substance. Volume is the number of transactions; substance looks at the size, materiality, continuity, and overall business character of the trading activity.

Practical takeaway

Even more than 500 trades can fail if trading days are limited and the overall activity pattern is not sufficiently regular and continuous.

5. Obayagbona — trader facts do not fix a bad election

Obayagbona v. Commissioner, T.C. Summary Opinion 2016-72 is also a nonprecedential Summary Opinion, but it remains useful as an educational example.

The lesson is straightforward: taxpayer arguments for trader status do not cure a defective or late Section 475 election.

Practical takeaway

TTS and mark-to-market treatment are separate. Qualifying as a trader does not automatically produce ordinary-loss treatment.

6. GWA — a technical but important Section 475 case

GWA, LLC v. Commissioner, T.C. Memo. 2025-34 arose in a partnership / basket-option substance-over-form context, not a typical individual active-trader TTS dispute.

Its Section 475 lesson is narrower and more technical than many summaries suggest. The Tax Court treated the trading activity of the disregarded entity as attributable to its owner, and it rejected an impermissibly selective Section 475 election that did not cover the taxpayer’s full securities-trading business.

The Tax Court also rejected the selective election problem because the election was not made with respect to the taxpayer’s entire business as a securities trader, and a taxpayer trading only securities cannot elect mark-to-market treatment for less than all of its securities-trading business.

Practical takeaway

The correct taxpayer must make the election, and the election cannot be selectively limited to only part of the securities-trading business.

Holding periods and the 31-day benchmark

Holding periods are one of the best indicators of whether a taxpayer is trying to capture short-term market swings.

GreenTraderTax uses an average holding period of 31 days or less as a practical benchmark. The IRS argued in Endicott that the average holding period of 35 days was too long. Traders should not read the cases as creating a simple safe harbor: courts still examine the full pattern of activity, including volume, frequency, continuity, trading days, and short-term trading intent.

Cases such as Holsinger v. Commissioner, T.C. Memo. 2008-191, Kay v. Commissioner, T.C. Memo. 2011-159, and Endicott v. Commissioner, T.C. Memo. 2013-199 support the broader point that longer holding periods weigh against trader status.

Practical takeaway

Shorter holding periods generally help, but courts still examine the full trading pattern.

Section 475: separate from TTS

One of the biggest trader-tax misunderstandings is confusing TTS with Section 475.

TTS is based on activity.
Section 475(f) requires a separate, valid, timely election by the correct taxpayer.
A trader can have a strong TTS fact pattern and still lose Section 475 treatment if the election was not made properly or on time.

Rev. Proc. 99-17 provides the exclusive procedure for traders in securities or commodities to make a Section 475 election.

For election timing and filing mechanics, see our Section 475 election-deadline guide.

How traders should use these lists

Start with the table of key benchmark and caution cases for planning and client education.
Use the foundation and Section 475 tables as deeper reference lists when comparing fact patterns.
Treat the cases as practical guidance, not numeric formulas.

Four practical reminders

TTS depends on actual trading activity.
720 trades is a planning benchmark, not a legal threshold.
Section 475 requires eligibility and a valid election by the correct taxpayer.
Segregate trading and investing: Keep trading-business positions separate from long-term investment positions, with clear records identifying which positions belong to each category.

2026 TTS Planning Checklist

Use these as planning targets, not legal requirements.

Trade count: Approximately 720 total trades per year.
Counting method: Count buys and sells separately.
Monthly pace: Around 60 trades per month.
Continuity: Spread trading across the year; avoid clustering activity into short bursts.
Trading days: Be active on a high percentage of available market days; our benchmark is 75%.
Holding period: Preferably 31 days or less on average as a planning benchmark.
Strategy: Focus on short-term market swings rather than long-term appreciation.
Documentation: Maintain trade logs, brokerage statements, expense records, time records, and business records.
Segregate trading and investing: Keep trading-business positions separate from long-term investment positions, with clear records identifying which positions belong to each category.
Other factors: See How To Qualify for TTS.
Section 475 deadline for existing traders: For 2026 treatment, attach the election statement to the timely filed 2025 return without extensions, or to a timely extension request, as required under Rev. Proc. 99-17, Section 5.03(1).
Section 475 for true “New Individual” Taxpayers: A new trader is not a new taxpayer if they have filed a prior-year individual federal tax return. Under Rev. Proc. 99-17 § 5.03(2), a true new individual taxpayer (e.g., a student or immigrant with no previous filing history) makes the election within 2 months and 15 days of starting operations.
Section 475 Entity Deadline Reset (75-Day Rule): If an existing individual misses the April 15 deadline, they can form a new entity (Partnership or S-Corp) later in the year to reset the clock. The new entity “adopts” Section 475 from inception via an internal books-and-records resolution within 75 days of inception—bypassing the need to file a Form 3115.
Correct taxpayer: If the entity is disregarded, the owner is generally the taxpayer who must make the election. The GWA court emphasized that, after a single-member LLC has disregarded status, elections are made by the single member, not by the disregarded entity itself.

When to get professional help

Traders should seek qualified tax advice before filing returns, making Section 475 elections, responding to IRS notices, or petitioning the Tax Court. Many trader-tax losses are avoidable compliance failures, not unavoidable legal defeats.

Final takeaway

The planning lesson is simple: build the TTS fact pattern, document the trading business, and make any Section 475 election on time and by the correct taxpayer.

In Essence

Trader Tax Status is not based on a single magic number; it depends on the trader’s overall activity pattern. Use the cases as guardrails, not safe harbors, and treat Section 475 as a separate compliance step that must be done correctly and on time.

RSU Stock and Investment Positions: Avoid Costly Section 475 Tax Traps for Traders

October 13, 2025 | By: Robert A. Green, CPA

Traders who receive RSU stock or hold investment positions in the same account as their trading activity can face hidden tax traps under Section 475(f). Learn how to avoid IRS reclassification, excess-business-loss deferrals, and mismatched tax treatment—while still benefiting from Trader Tax Status and Section 475’s powerful advantages.

A Common Issue for Active Traders

Many active traders who qualify for Trader Tax Status (TTS) and elect Section 475(f) mark-to-market (MTM) treatment also receive restricted stock units (RSUs) from their employers, especially in the technology, finance, and biotech sectors.

When RSUs vest, their fair market value (FMV) is taxed as ordinary income, subject to W-2 withholding. Some traders then transfer those vested shares into their Section 475 trading accounts, assuming the shares automatically qualify as part of the trading business.

Unfortunately, the IRS disagrees. Avoid this problem by selling the RSU-acquired public-company stock and repurchasing it in your TTS trader account. The trader below did not—and ended up with significant phantom income and NOL carryforwards.

(For a basic overview of Trader Tax Status, see IRS Topic No. 429: Traders in Securities.)

IRS Position: RSU Stock Is Not Section 475 Property

RSUs are deferred-compensation property governed by Section 83. No stock is owned until the vesting date, when the employee gains unrestricted rights to the shares. At that time, the FMV becomes ordinary wage income, reported on Form W-2, and it becomes the tax basis.

Acquisition Timing:
The RSU shares are considered acquired on the vesting date, not when deposited into a brokerage or trading account. The subsequent deposit of shares is an administrative action only—it does not change the character of the stock from compensation property to trading property. Even if the shares are immediately transferred into a trader’s Section 475 account, they remain compensation assets governed by Section 83, not trading assets under Section 475(f).

Public vs. Private RSUs:
This rule applies to both public and private company RSUs. Private-company RSUs often include “double-trigger” vesting (time + liquidity). Even after a liquidity event, the shares remain compensation property under Section 83, not trading property under Section 475(f).

Even if the shares are deposited directly into a trader’s MTM account, they were acquired through employment, not through the trading business. Therefore, they fall outside Section 475(f). Section 475 applies only to securities acquired and held in connection with a trading activity, not to compensation or investment assets merely moved into the account.

IRS Chief Counsel Advice 201432016 (Aug. 8, 2014) supports this conclusion (while a CCA is not precedential, it reflects the IRS’s administrative interpretation and is generally followed in practice):

“Section 475(f) applies only to securities held for trading in the ordinary course of a trade or business. Merely transferring such securities into a trading account does not convert them into property held in connection with the trading business.”

Under Proposed Reg. § 1.475(f)-2(a)(2)–(4), RSU-acquired shares are compensation assets, not trading property, and therefore excluded from Section 475(f) mark-to-market accounting—even if later transferred. Although still proposed, these regulations have guided IRS practice since 1998 and remain the accepted authority.

Although the proposed regulation does not explicitly mention employment-related compensation property, its framework distinguishes between trading and non-trading assets. RSU shares fall outside Section 475 because they are governed by Section 83 as compensation property—not acquired in the ordinary course of a trading business. This interpretation is supported by IRS Chief Counsel Advice 201432016 and has been consistently applied by the IRS in its administrative practice.

Once vested, RSU shares have a basis equal to the amount already included in W-2 income, and any subsequent gain or loss is capital, not ordinary. Since the shares were not acquired for trading purposes, Section 475 cannot be applied retroactively.

Brokerage Note: The RSU cost basis is often omitted on Form 1099-B, resulting in an overstated gain. To avoid double taxation, adjust the basis on Form 8949 to include amounts already taxed through W-2 income.

Example: How Mismatched Character and the EBL Limit Create a Tax Trap

A trader receives $1 million of employer stock at RSU vesting (already taxed through payroll) and moves it into the trading account. Later, they trade the position and realize a $750,000 gain, while incurring $900,000 of ordinary trading losses under Section 475(f).

If the RSU stock were ordinary under Section 475, the $750,000 gain would offset most of the $900,000 loss, leaving a net business loss of $150,000 within the Excess Business Loss (EBL) limitation.

However, the IRS treats the RSU shares as capital assets. Even though the trader has an economic loss of $150,000, they owe tax on phantom income of $124,000 because the EBL limit for 2025 is $626,000 (MFJ) / $313,000 (single). The remaining $274,000 EBL becomes an NOL carryforward, usable later but offering no immediate relief.

An NOL carryforward is generally superior to a capital loss carryover, because the NOL can offset income of any kind in future years. In contrast, capital losses may only offset capital gains (plus $3,000 per year against ordinary income). The EBL limitation is indexed annually for inflation, so it primarily affects traders with substantial losses.

The trader could have avoided this problem by selling the RSU-acquired stock when vested and repurchasing it inside their TTS trading account.

A Similar Trap for Traders with Investment Positions

Before discussing portfolio margining and holding period issues, let’s first address the process of transferring assets from a non-MTM investment account into a Section 475(f) trading account.

Moving a security from an investment account into a trading account does not convert it into Section 475 property. To qualify for mark-to-market treatment, a position must be acquired and held in connection with the trading business—not merely transferred after acquisition.

When a trader first elects Section 475(f), a Section 481(a) adjustment converts opening-year TTS trading positions (previously reported under the realization method) into mark-to-market assets by revaluing those securities to fair market value on the first day of the election year. The difference between the prior-year basis and the MTM value becomes the Section 481(a) adjustment, ensuring a clean transition into the new accounting method.

Under Prop. Reg. § 1.475(f)-2(a)(2)–(4) and Section 475(f)(1)(B)(ii), traders must make timely same-day identifications of any investment-held securities to preserve segregation. Once identified, those positions remain permanently outside Section 475 treatment.

Suppose a trader later trades options around those investment positions (for example, selling covered calls). In that case, the stock remains a capital asset, while the option trades can qualify for Section 475 ordinary treatment.

To avoid potential IRS reclassification or mixed-character outcomes, traders should ring-fence their long-term investments in separate individual or joint accounts and/or conduct their TTS/Section 475 activity in an entity account with its own Employer Identification Number (EIN).

Court Cases Reinforce the IRS Position

In Endicott v. Commissioner (T.C. Memo 2013-199), the Tax Court held that holding significant equity positions while trading options around them resembled investment management, rather than an active trading business. The average holding period exceeded 31 days, which the IRS still uses as a bright-line benchmark for TTS analysis.

Similarly, in Holsinger v. Commissioner (T.C. Memo 2008-191), monthly option trading failed the frequency and continuity tests for TTS. Both cases involved portfolio margining that blurred the line between investing and trading, thereby undermining TTS eligibility.

Takeaway: Mixing long-term investments and trading in one account can jeopardize both TTS and Section 475 benefits. Use separate accounts or entities to clearly ring-fence your trading business.

Broader Section 475 Mismatch Risks

While Section 475(f) is typically the most tax-efficient method for active traders, mismatches can occur when some income is classified as capital gain and some as ordinary income. The EBL limits ($313,000 single / $626,000 MFJ for 2025) are relatively high, and most traders don’t lose enough to be affected. Conversely, a trader might have Section 475 income and capital losses, creating the reverse problem.

Example: The Reverse Mismatch

A trader has an $800,000 Section 475(f) MTM gain and sells long-term investment stocks at a $300,000 capital loss. Because the loss is capital, it cannot offset the ordinary 475 income. The trader pays tax on the full $800,000 of ordinary income while carrying forward the $300,000 capital loss, which is usable only against future capital gains ($3,000 per year against ordinary income).

A similar trap arises if RSU stock drops in value after vesting—the subsequent sale produces a capital loss that cannot offset Section 475 ordinary trading income, leaving the trader with higher taxable income despite an overall economic loss.

These mismatches underscore the importance of meticulous planning, account segregation, and accurate year-end tax projections.

Why Section 475(f) Still Matters

Despite these pitfalls, Section 475 remains the best framework for most active traders. Its benefits are substantial:

Converts trading results to ordinary income or loss
Eliminates wash-sale rules
Bypasses the $3,000 capital-loss limit
Enables the 20% Qualified Business Income (QBI) deduction for profitable TTS traders operating as pass-through entities or Schedule C sole proprietors

(SSTB phase-out range for 2025: $394,600–$494,600 MFJ / $197,300–$247,300 single)

Even traders below these thresholds can enjoy the full 20% QBI deduction—another reason Section 475 remains powerful.

California Makes It Even Tougher

California conforms to the federal EBL limit and has suspended NOL deductions for 2024–2026 if AGI exceeds $1 million. This suspension applies even to business losses under Section 475(f).

Any disallowed EBL becomes part of a California NOL carryforward but cannot be used until the suspension lifts. Budget bills SB 167 and SB 175 could be reinstated earlier if state revenues recover.

Audit Checklist: Section 475(f) and TTS Compliance Essentials

Adjust the RSU basis on Form 8949 to reflect W-2 income already reported
Make timely written identifications of investment positions per Prop. Reg. § 1.475(f)-2(a)(2)–(4)
Consider separate entities (with distinct EINs) to ring-fence trading vs. investing
Document Section 475 elections and revocations with timely-filed notification statements to the IRS and Form 3115 per Rev. Proc. 2025-23 — see GreenTraderTax: New IRS Rules — Section 475 MTM Revocation Now Locked for Five Years
Segregate trading and investment accounts at the broker level
Track average holding periods (≤ 31 days) to support TTS qualification

Need Professional Guidance?

Each trader’s facts are unique—especially when RSU stock, segregated investments, and Section 475 intersect.

CPAs at Green, Neuschwander & Manning, LLC (GNM) can help you analyze your facts, minimize mismatches, and plan for 2025 and beyond.

👉 Schedule a consultation at GreenTraderTax.com

Sources & Further Reading

IRS Chief Counsel Advice 201432016 (Aug. 8, 2014)
Proposed Reg. § 1.475(f)-2(a)(2)–(4)
Section 475(f)(1)(B)(ii) identification requirement
Endicott v. Commissioner, T.C. Memo 2013-199
Holsinger v. Commissioner, T.C. Memo 2008-191
Rev. Proc. 2025-23 — Section 475 Revocation Lock-In Rule
IRS Topic No. 429 — Traders in Securities
California FTB NOL Suspension 2024–2026
Articles on Section 475 and TTS at GreenTraderTax.com

Tips for Options Traders on Preparing 2024 Tax Returns

February 14, 2025 | By: Robert A. Green, CPA

As we move into tax season, options traders must be mindful of how their trading activities impact their tax filings. Understanding the nuances of tax treatment for various types of options, trader tax status (TTS), and available elections can significantly affect your tax liability. This guide provides key insights from Robert A. Green, CPA, on effectively preparing your 2024 federal tax returns.

Equity Options, Wash Sales, and Section 475

Equity options are classified as securities, which means they are subject to wash sale loss (WS) rules. Wash sales occur when a trader sells a security at a loss and then repurchases a substantially identical security within 30 days. Importantly, brokerage firms often do not report WS between equities and equity options on Form 1099-B, but the IRS still requires traders to track these transactions manually.

Traders with TTS can elect Section 475 mark-to-market (MTM) accounting, which exempts securities from wash sale rules and the $3,000 capital loss limitation. The Section 475 election for 2024 was due by April 15, 2024, with the next election deadline set for April 15, 2025.

Futures Options and Section 1256 Contracts

Futures options are classified as Section 1256 contracts. These contracts benefit from lower 60/40 capital gains tax rates, simplified tax reporting, and a Section 1256 loss carryback election, making them more tax-efficient than securities-based options.

Tax Treatment of Options

Options trading involves diverse tax treatments depending on the type of option contract:

Options taxed as securities: These include stock options, options on narrow-based indexes, and options on ETFs structured as registered investment companies (RICs).
Options taxed under Section 1256 include options on U.S.-regulated futures contracts, broad-based indexes, and CBOE-listed options on specific commodity and volatility ETFs and ETNs.

Wash Sale Loss Rules for Security Options

For options classified as securities, wash sales apply to all accounts, including taxable and IRA accounts. Since brokers calculate WS on an account-by-account basis, traders should consider using tax software like TradeLog to track these adjustments accurately.

Simple vs. Complex Options Trades

Simple options strategies, such as buying and selling single-leg calls and puts, have relatively straightforward tax treatment. However, complex options trades, such as spreads, iron condors, and butterflies, trigger additional IRS regulations to prevent tax avoidance through offsetting positions.

Trader Tax Status (TTS) and Business Expense Deductions

Traders who qualify for TTS can deduct business expenses on Schedule C of their tax return. Key TTS qualification factors include:

Trade Volume: A minimum of 720 trades annually.
Frequency and Holding Period: Trading activity on 75% of trading days, with an average holding period of 31 days or less.
Time Spent: More than four hours daily engaged in trading-related activities.
Intent and Operations: Operating with the intention of making a living from trading.

Tax Reporting for a Sole Proprietor Trading Business

Different IRS tax forms apply based on the type of trading activity:

Schedule C: Reports business expenses but not trading gains or losses.
Form 8949 and Schedule D: Used for reporting securities sales and calculating capital gains and losses.
Form 4797: Reports trades under Section 475 MTM for TTS traders, allowing ordinary gain or loss treatment.
Form 6781: Summarizes Section 1256 contracts with the 60/40 tax split.

Section 475 MTM Election

TTS traders may elect Section 475 MTM to benefit from ordinary income tax treatment and exemption from wash sale losses. The election must be made by April 15, 2025, for the 2025 tax year. You can elect it on securities only to retain lower 60/40 tax rates on futures.

Qualified Business Income (QBI) Deduction

Under the Tax Cuts and Jobs Act (TCJA), TTS traders may qualify for a 20% deduction on QBI derived from Section 475 trading gains. However, this deduction will be phased out for married filers with taxable incomes above $383,900 and single filers above $191,950 in 2024.

Tax Treatment for Various Financial Products

Different financial instruments have unique tax treatments:

U.S. and International Equities: Subject to capital gains tax.
Futures and Section 1256 Contracts: Benefit from the 60/40 tax split on capital gains.
Options on ETFs and ETNs: Depending on structure, they may be taxed as securities or Section 1256 contracts.
Cryptocurrencies: capital gains and losses on property using the realization method.
Forex: Typically taxed as ordinary income under Section 988 unless an election is made for capital gains treatment, including 60/40 for major pairs.

Navigating Form 1099-B and Trade Accounting

Many traders experience discrepancies between broker-provided Form 1099-B and IRS requirements, particularly with wash sale loss adjustments. Using software like TradeLog can help traders correctly calculate and report their trading activity in compliance with IRS rules.

Final Thoughts

Understanding the complexities of options taxation is essential for traders aiming to minimize tax liability and ensure compliance with IRS regulations. Traders should consult with a tax professional, such as those at GreenTraderTax.com, to optimize their tax situation and make informed decisions for 2024 and beyond.

For more guidance on tax treatment for options trading, get Green’s 2025 Trader Tax Guide.

This blog post is for educational purposes and does not constitute tax advice. Always consult a qualified tax professional for personalized guidance.

Trader Tax Status Demystified: Qualify, Save, and Succeed

January 9, 2025 | By: Robert A. Green, CPA

Trader tax status (TTS) allows active traders to claim significant tax benefits by treating trading as a business. Unlike investors, who are limited in the deductions they can take, traders with TTS can deduct various business expenses and avoid certain restrictions imposed on investment-related losses.

This summary of Chapter 1 of Green’s 2025 Trader Tax Guide explains the Trader Tax Status (TTS) concept.

Key Highlights:

Eligibility Criteria for TTS:
- No formal election is required for TTS; it is determined based on facts and circumstances.
- Traders must meet qualitative and quantitative criteria, including:
  - Volume: A substantial number of trades (typically 60+ trades per month for several months, or 720+ trades annually).
  - Frequency: Consistent trading activity on most trading days (around 4 days per week, 75% of available trading days).
  - Holding Period: The average holding period of securities should be less than 31 days.
  - Time Commitment: Traders should spend a significant amount of time (around 4+ hours per day) managing their trading business.
  - Intention: The primary goal should be to profit from short-term price fluctuations, not long-term investment.
Benefits of TTS:
- Deduction of Business Expenses: Traders with TTS can deduct expenses related to trading, such as:
  - Home office
  - Market data subscriptions
  - Trading education
  - Software and equipment
- Avoidance of Hobby Loss Rules: Since trading is recognized as a business, losses are treated as business losses rather than hobby losses.
- Eligibility for Section 475 MTM Accounting: Traders who qualify for TTS may elect Section 475 Mark-to-Market (MTM) accounting, allowing them to:
  - Treat trading gains and losses as ordinary income and loss.
  - Avoid the $3,000 capital loss limitation.
  - Bypass wash-sale rules.
  - Eligible for the 20% qualified business income deduction.
Important Considerations:
- No Consistency Requirement: Traders may qualify for TTS in one year but not the next, depending on their trading activity.
- Partial-Year Qualification: Qualifying for TTS for only part of a year if trading activity stops or starts mid-year is possible.
- IRS Scrutiny: Since TTS offers significant tax benefits, TTS claims can attract the IRS’s attention. Maintaining detailed records of trading activity, hours worked, and business-related expenses is essential.
Common Challenges:
- Part-time traders, retirees, and those with another full-time job may face higher scrutiny from the IRS when claiming TTS.
- Automated trading systems (ATS) or trade copying services may not qualify unless the trader is actively involved in strategy development and execution.

Practical Tips:

Keep detailed logs of trades, hours worked, and the nature of trading activity.
Consider forming an entity (e.g., LLC with S-Corp election) to strengthen the TTS claim and unlock additional benefits such as health insurance and retirement plan deductions.
Include explanatory footnotes in tax returns to support TTS qualification.

This chapter lays the foundation for understanding the benefits and requirements of treating trading as a business and emphasizes the importance of proper documentation and strategy in maximizing tax advantages.

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.

ChatGPT Explains Trader Tax Benefits

May 26, 2023 | By: Robert A. Green, CPA

I prompted Bing’s ChatGPT to write blog posts on “trader tax benefits” and “trader tax status.” See my comments in yellow highlight. I also used Grammarly. ChatGPT did a good job, but gave rudimentary advice. There are nuances in our content that ChatGPT missed. GreenTraderTax and my Forbes articles are a source for ChatGPT’s blog posts.

Trader Tax Benefits:

If you are an active trader buying and selling securities for a living, you may wonder how to save money on taxes. One way to do that is to qualify for trader tax status (TTS), which allows you to deduct various business expenses and take advantage of unique tax treatments. This blog post will explain TTS, its benefits, and how to qualify.

What is trader tax status?

Trader tax status is a designation that the IRS grants to certain traders who meet specific criteria. It is not an election you can make; you must prove (assess) that you are eligible based on your trading activity and intention. Trader tax status allows you to treat your trading income and expenses as a business rather than an investor. You can deduct your trading-related expenses on Schedule C, such as commissions (wrong), software, education, interest, and home office. (Deduct brokerage commissions from sales proceeds and add them to cost basis when reporting capital gains and losses or Section 475 income.)

You can also elect to use Section 475 mark-to-market accounting, which converts your capital gains and losses into ordinary income and losses. Section 475 can help you avoid the wash sale rule and the $3,000 capital loss limitation. Additionally, if you form an LLC or a corporation and elect S-corp status, you can deduct health insurance premiums and retirement plan contributions as employee benefits.

How to qualify for trader tax status?

The IRS does not have a clear-cut definition of trader tax status, but it does provide some guidelines based on court cases and rulings. Generally, you must meet the following requirements:

– You trade substantially, regularly, frequently, and continuously throughout the year. You have to meet no specific number of trades or hours, but the IRS expects you to trade almost every day that the market is open and execute hundreds of transactions per year.

– You seek to profit from short-term price swings of securities rather than dividends, interest, or long-term appreciation. You typically hold your positions for less than a day or a few days at most (an average holding period of fewer than 31 days per the Endicott court is required).

– You intend to trade as a business, not as a hobby or a passive investment. You have a trading plan, a trading account separate from your (investment) account, and a dedicated workspace or office.

It would be best if you met these criteria consistently throughout the year. You may not qualify for trader tax status if you start or stop trading during the year or have significant gaps in your trading activity. (Part-year TTS qualification is okay.)

What are the benefits of trader tax status?

Trader tax status can provide significant tax savings for active traders. Here are some of the main benefits:

– You can deduct your trading expenses on Schedule C, reducing your adjusted gross income (AGI) and self-employment tax. These expenses include commissions (not brokerage commissions), software, subscriptions, education, interest, margin fees, and home office costs.

– You can elect Section 475 mark-to-market accounting, which allows you to report your trading gains and losses as ordinary income and losses on Form 4797. This way, you can avoid the wash sale rule, which disallows losses on (substantially identical) securities you buy back within 30 days (before or after). You can also fully deduct (within Excess Business Loss EBL and net operating loss NOL limitations) your trading losses against any income without being subject to the $3,000 capital loss limitation or the 3% (2%) AGI threshold for itemized deductions. (The 2017 Tax Cuts and Jobs Act TCJA suspended 2% miscellaneous itemized deductions from 2018 through 2025.)

– You can qualify for the 20% qualified business income (QBI) deduction if you have Section 475 income and your taxable income is below a certain threshold ($164,900 for single filers and $329,800 for married filing jointly in 2021). The QBI deduction reduces your taxable income by 20%, which lowers your effective tax rate.

– You can form an LLC or a corporation and elect S-corp status, which allows you to pay yourself a reasonable salary and deduct health insurance premiums and retirement plan contributions as employee benefits. These deductions also reduce your AGI and your self-employment tax.

Conclusion

Trader tax status is a valuable tax benefit for active traders who meet specific criteria. It allows you to deduct various business expenses and take advantage of unique tax treatments that lower your taxable income and tax liability. However, qualifying for trader tax status is tricky; you must (be ready to) prove (in an IRS exam) that you trade as a business with sufficient frequency, volume, and consistency. You must also comply with various rules and regulations regarding accounting methods, entity structures, and tax filings. Therefore, it is best to consult a professional trader tax advisor who can help you determine if you are eligible for trader tax status and how to maximize its benefits.

Trader Tax Status:

If you are an active trader who buys and sells securities for a living, you might be interested in trader tax status (TTS). (The intention of making a living is good enough). TTS is a special designation that allows you to deduct your trading expenses as business expenses and enjoy other tax benefits. However, only some people who trade qualify for TTS. You must meet certain criteria and follow specific rules to claim this status.

What are the benefits of trader tax status?

Trader tax status comes with several advantages, such as:

– You can deduct your trading-related expenses, such as margin interest, education, software, data feeds, subscriptions, home office, and more. These expenses are reported on Schedule C or the pass-through entity tax return, reducing your taxable income.

– You can elect Section 475 mark-to-market (MTM) accounting for your trading securities. You can treat your open positions as sold at fair market value on the last day of the year and report the unrealized gains or losses as ordinary income or loss. (Section 475 realized gains and losses are ordinary gains or losses, too.) This way, you can avoid the wash sale rules that defer losses on securities and the $3,000 capital loss limitation. Although this is uncertain, you might also qualify for the 20% qualified business income deduction on your Section 475 income.

– (Using an S-Corp), you can set up a retirement plan for yourself and your spouse (if applicable) and make tax-deductible contributions. A retirement plan can help you save for your future and lower your tax bill.

How do you qualify for trader tax status?

There is no election or application for trader tax status. It is based on your facts and circumstances and how you conduct your trading activity. The IRS needs to define TTS clearly, but it has provided some guidelines and court cases to help you determine eligibility.

According to the IRS, to qualify for trader tax status, you must:

– Trade substantially, regularly, frequently, and continuously. You need to meet no fixed number of trades or hours per day or week, but generally, the more trades and time you devote to trading, the better. A good rule of thumb is to average at least four daily transactions and 15 hours per week. (Green looks for a frequency of nearly four days a week with trade executions.)

– Seek to profit from short-term price swings of securities. It would be best if you did not hold securities for long-term appreciation or income. Your holding period should be less than 31 days on average.

– Have the intention to trade as a business. You should treat your trading activity as a serious and professional endeavor, not a hobby or a personal investment. You should have a separate trading account (or accounts), a dedicated workspace, a written trading plan, and proper records and reports.

How do you claim trader tax status?

If you meet the criteria for trader tax status, you can claim it on your tax return by reporting your trading expenses on Schedule C or the pass-through entity tax return. I would also like to ask you to please attach a statement explaining why you qualify for TTS and how you calculated your costs.

Suppose you want to elect Section 475 MTM accounting for your trading securities. In that case, you must file a timely election statement with the IRS by April 15 of the current year (or March 15 for partnerships and S corporations). You should also attach a copy of the election statement to your tax return. (New entities can elect Section 475 by internal resolution within 75 days of inception.)

If you want to set up a retirement plan for yourself and your spouse (if applicable), you must do so by December 31 of the current year. (A SEP IRA can wait until the tax return due date.) You can choose from various plans, such as a Solo 401(k), a SEP IRA, or a defined benefit plan. You should consult a tax professional to determine which plan is best for you and how much you can contribute.

Conclusion

Trader tax status is a valuable tax benefit for active traders who qualify. It allows you to deduct your trading expenses as business expenses and elect Section 475 MTM accounting for your trading securities. It also enables you to set up a retirement plan for yourself and your spouse (if applicable) and make tax-deductible contributions. (You need a TTS S-Corp to deduct a retirement plan and 2% owner health insurance premiums.)

However, trader tax status is not automatic or easy to obtain. You must meet certain criteria and follow specific rules to claim this status. You must also keep accurate records and reports of your trading activity and expenses. You should seek professional advice from a CPA or a tax attorney specializing in trader taxation before claiming TTS on your tax return.

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.

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.

How to Set Up A Trading Business For Optimal Tax Savings

June 18, 2022 | By: Robert A. Green, CPA | Read it on

If you are eligible for trader tax status (TTS), consider setting up a trading business to maximize tax benefits. Some traders benefit from an LLC; others don’t need one.

Deduct trading business expenses. 
Elect Section 475 MTM for exemption from wash sales and the capital loss limitation. 
Be eligible for a 20% qualified business income QBI deduction on Section 475/TTS income. 
Deduct health insurance and high-deductible retirement plan contributions. 
Deduct state and local taxes (SALT) as a pass-through entity (PTE) business expense avoiding the $10,000 SALT cap.

How to be eligible for trader tax status

Volume: Make four trades per day, 16 trades per week, 60 a month, and 720 per year on an annualized basis (Poppe court). Count each open and closing transaction separately.

Frequency: Executes 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’s a bright-line test.

Trade full-time or part-time. For a good portion of the day, the markets are open.

Hours: Spend more than four hours daily, almost every market day, working on the trading business — all time counts.

Avoid sporadic lapses: Once TTS commences, avoid lapses in the trading during the year. Trading must be regular, frequent, and continuous.

Intend to run a business and make a living. It doesn’t have to be a primary living. 

Operations: Have significant business equipment, 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.

See https://greentradertax.com/trader-tax-center/trader-tax-status/how-to-qualify/

What doesn’t qualify for TTS?

A third party creates the automated trading system (ATS) with entry and exit signals and mechanical execution. Some ATS don’t come with automatic execution, and traders significantly depart from ATS signals so that the trader can count those trades. A self-created ATS counts for TTS. Many traders come from the tech world and design and code an ATS.

A trade copying service does not count for TTS unless you depart from recommended trades significantly.

Engaging an outside investment advisor.

Trading in retirement funds.

Choice Of Entity

File a Schedule C with Form 1040

An individual TTS trader deducts business expenses, startup costs, and home office deductions on a Schedule C (Profit or Loss From Business – Sole Proprietorship) as part of the 1040 filing.

Traders don’t have revenue on Schedule C; they report trading gains and losses on other tax forms.

Schedule C expenses are an above-the-line deduction from gross income.

TTS Schedule C expenses also reduce self-employment income (SEI). However, trading income is not SEI unless you are a full futures exchange member per Section 1402(i).  

Trading income is net investment income (NII) for the 3.8% net investment tax on NII over ACA thresholds.

Individual brokerage account

You can establish an individual brokerage account(s) in the trader’s name and social security number.

You can also use a joint individual account, but first, list the trader’s name and social security number.

If the husband trades the spouse’s account, neither can qualify for TTS.

Individuals pay non-professional rates for real-time data, whereas entities might owe higher professional rates.

No election or filing need for TTS

There isn’t a tax election for claiming TTS — it’s determined based on facts and circumstances assessed at year-end.

A TTS trader can elect Section 475 to treat MTM as ordinary gain or loss. But the 475 election is due early in the tax year.

TTS is like undergraduate school, and Section 475 is like grad school. You can claim TTS after the fact, but not 475. That hurts many traders in 2022, especially if they rack up massive losses and miss the 475-election deadline for existing individuals due by April 18, 2022. (March 15 for partnerships and S-Corps).

Single-member LLC

If you want asset protection, consider a single-member LLC (SMLLC) taxed as a “disregarded entity.” That’s a “tax nothing” in the eyes of the IRS. You still file as a TTS sole proprietor on Schedule C. 

Traders don’t have investors or clients; that would be an investment management business subject to liability concerns.

A TTS trader might hire employees, lease an office, co-locate automated trading equipment with a broker, and use massive leverage. These traders should consider liability protection using an SMLLC. Consult an attorney.  

An SMLLC can also elect S-Corp or C-Corp tax status.

Business expenses with trader tax status

Tax-deductible business expenses include home-office, education, startup expenses, organization expenses, margin interest, tangible property expense, Section 179 (100%) or 100% bonus depreciation, amortization on software, self-created automated trading systems, mentors, seminars, market data, charting services, stock borrow fees, and much more.

See https://greentradertax.com/trader-tax-center/trader-tax-status/trading-business-expenses/

Section 475 tax benefits

TTS traders are entitled to make a Section 475 election, but investors may not.

The election exempts securities trades from wash-sale loss (WS) adjustments, which can defer tax losses to the subsequent year and the $3,000 capital loss limitation. Ordinary loss treatment is better; it can generate tax refunds faster.

A TTS/475 trader is eligible for a 20% qualified business income (QBI) deduction if under the taxable income threshold for a “specified service trade or business” (SSTB). QBI includes 475 ordinary income less TTS expenses, excluding capital gains and portfolio income.

Section 475 election process

The deadline for a TTS trader to elect Section 475 for 2022 has passed; it was April 18, 2022, for individuals and March 15, 2022, for existing partnerships and S-Corps.

A partnership or S-Corp formed during the tax year is considered a “new taxpayer,” which can elect Section 475 internally within 75 days of inception. A new entity comes in handy for selecting 475 later in the year.

See https://greentradertax.com/how-traders-elect-475-to-maximize-their-tax-savings/

The qualified business income deduction

TCJA introduced a tax benefit for pass-through businesses, which includes a TTS trader with Section 475 income: whether doing business as a sole proprietor, partnership, or S-Corp.

Section 199A provides a 20% QBI deduction on a “specified service trade or business” (SSTB), and TTS trading is an SSTB.

SSTBs are subject to a taxable income threshold, phase-out range, and an income cap. The phase-out range has wage and property limitations, too.

As an SSTB, TTS traders have a taxable income (TI) cap of $440,100/$220,050 (married/other taxpayers) for 2022. The phase-out range below the cap is $100,000/$50,000 (married/other taxpayers), in which the QBI deduction phases out for SSTB. The W-2 wage and property basis limitations also apply within the phase-out range.

For example, on $100,000 of TTS/475 income, the trader might get a $20,000 tax deduction.

LLC taxed as a partnership

A TTS trader can organize a spousal-member LLC and file as a partnership. Only one spouse needs to be an active trader.

LLC/partnerships file a Form 1065 partnership tax return and issue Schedule K-1s to owners.

LLC/partnerships must qualify for TTS; otherwise, they are investment companies.

With TTS, report business expenses on page one of 1065. List net 475 income or loss, less TTS expenses on line one of the Schedule K-1 “ordinary business income (loss).” Use separate K-1 line items for portfolio income, including capital gains and losses, interest, and dividends.

The owner reports Schedule K-1 ordinary business income (loss) on Form 1040 Schedule E in the active column.

It’s not a passive activity in Section 469 under the “trading rule” exception. However, losses are limited to “basis” (your net investment in the partnership). (Sole proprietor TTS traders also need a basis for deducting losses.)

Report capital gains/losses and portfolio income separately on 1040—schedule B for interest and dividend income and Schedule D for capital gains and losses from partnerships.

If the partnership agreement provides for it, the partner can also deduct “unreimbursed partnership expenses” (UPE), including home office expenses, on Schedule E page 2. (It’s more formal with an S-Corp.)

An LLC/partnership provides a ring-fencing solution and the SALT cap workaround strategy. It cannot generate earned income for the health and retirement plan deductions; you need an S-Corp for employee benefits.

Ring-fence trading from investments with a partnership or S-Corp

If you trade substantially-identical positions that you invest in a taxable account, it could invite the IRS to play havoc with reclassification. It can also undermine eligibility for TTS. For example, you invest in Apple and Microsoft equities for the long-term and also trade Apple and Microsoft equity options around those investment positions.

A partnership or S-Corp can fix this problem. The entity can ring-fence TTS/475 trading positions, segregating them from overlapping investments on the individual level. But that isn’t easy if you want to maximize portfolio margining.

This entity solution prevents the IRS from reclassifying TTS positions out of Section 475 ordinary losses into a capital loss limitation and, alternatively, reclassifying unrealized long-term capital gains into MTM income.

If you don’t have overlapping investments, you don’t need a ring-fencing entity solution.

Avoid permanent wash sale losses between taxable and IRA accounts

If you trade substantially-identical positions that you also invest in IRAs, it could trigger losses for permanent wash sale loss adjustments (WS). Brokers don’t recognize this problem on 1099-Bs; the IRS permits them to take a narrow view of WS. 

Take a loss on X in a taxable account and repurchase X within 30 days before or after in an IRA, and it’s a permanent WS loss. There is no way to record the WS cost basis adjustments in the IRAs; hence it’s permanent. Conversely, with WS in taxable accounts, you defer the loss to the replacement position, which the broker does on the 1099-B.

There are three ways to avoid these IRA-generated WS. Use a do not trade or invest list to prevent overlap, elect 475 on trades, or use a ring-fencing entity solution. If you only trade an IRA account, there is no WS; it’s only a problem between taxable vs. IRS accounts with overlap.

SALT cap workaround laws

In 2018, TCJA capped SALT itemized deductions at $10,000 per year, including state and local income taxes, property, and sales taxes. Over 20 states provide relief with SALT cap workaround laws. Business owners of partnerships or S-Corps are entitled to make SALT payments through the entity and get a credit on their individual tax returns. That converts non-deductible SALT into a business expense.

Search “SALT cap workaround” with your state. Act on time to get this deduction; it requires planning.

See https://greentradertax.com/category/salt/

LLC taxed as an S-Corp

Organize a single-member or spousal-member LLC and elect S-Corp status with the IRS within 75 days of inception (date on the certificate of formation).

Alternatively, in a subsequent year, the LLC can submit an S-Corp election by March 15.  

Owners must be U.S. residents.

An LLC/S-Corp can achieve the ring-fencing and SALT cap workaround solutions of partnerships previously discussed.  Consider an S-Corp if you also want health insurance and retirement plan deductions.

See https://greentradertax.com/trader-tax-center/entity-solutions/

Health insurance deduction with an S-corp

TTS traders with significant health insurance (HI) premiums should consider an S-Corp to arrange an AGI tax deduction.

The trader or spouse might have another source of self-employment income to deduct HI. A spouse might have HI coverage for the family in their job. Cobra is not deductible HI since it’s employer-provided.

Add reimbursement of HI premiums to officer compensation, and that portion of salary is not subject to payroll taxes (social security and Medicare). The trader then can take an AGI deduction for the HI premiums on their Form 1040. (It’s quirky).

A TTS sole proprietor or partnership cannot deduct HI based on trading income.

Retirement plan contribution/deduction with an S-Corp

Traders need “earned income” to make and deduct retirement plan contributions and health insurance premiums; however, trading income is unearned.

TTS sole proprietors and partnerships cannot create earned income, whereas S-Corps can pay officer compensation, generating earned income.

Payroll taxes apply on officer compensation (wages): 12.4% FICA capped on salaries up to $147,000 for 2022, and the 2.9% Medicare is unlimited. There’s a 0.9% surtax over the ACA income threshold.

Upper-income traders convert Medicare tax on unearned income (net investment tax) into Medicare on earned income, so it’s not redundant.

Annual payroll at year-end

TTS traders should fund retirement plan contributions from net income, not losses.

It’s okay to have a loss generated by the HI reimbursement portion of compensation.

It’s best to wait on the execution of an annual paycheck until early December when there is transparency for the year.

Solo 401(k) elective deferral

If you have sufficient trading profits for the year, consider establishing a Solo 401(k) retirement plan before year-end.

Start with the 100% deductible elective deferral (ED; $20,500 for 2022) and pay it through payroll. Deduct it on the annual W-2.

Taxpayers 50 years and older have a “catch-up provision” of $6,500, raising the 2022 ED limit to $27,000 annually.

The ED can be contributed to a Roth IRA, forgoing the tax deduction on the contribution. Roth plans are permanently tax-free, whereas traditional programs provide deferral of income.

Solo 401(k) profit-sharing plan

Consider a 25% deductible Solo 401(k) profit-sharing plan (PSP) contribution if you have sufficient trading gains. Increase payroll in December 2022 for a performance bonus. You don’t have to pay into the retirement plan until the due date of the S-Corp tax return (including extensions by September 15, 2023).

The maximum PSP amount for 2022 is $40,500, increased by $2,000 from 2021.

The total 2022 limit for a Solo 401(k) is $67,500 ($20,500 ED, $6,500 catch-up ED, and $40,500 PSP).

See https://greentradertax.com/trader-tax-center/retirement-solutions/ and 

https://greentradertax.com/how-some-traders-double-up-on-retirement-plan-contributions/

https://www.shrm.org/ResourcesAndTools/hr-topics/benefits/Pages/irs-benefits-contributions-limits-chart-2022.aspx

C-Corps are not suitable for traders

C-Corps are not ideal for traders since the IRS might charge a 20% “accumulated earnings tax” (AET) on top of the 21% flat tax rate.

It’s hard for a trader to have a war chest plan to justify retaining earnings and profits (E&P). Otherwise, AET applies to E&P.

There’s double state taxation to consider, too.

See https://greentradertax.com/how-to-decide-if-a-c-corp-is-right-for-your-trading-business/

Traders are eligible for some business tax benefits and have unique needs. For example, their income is unearned, yet it can qualify for QBI deductions with a 475 election and the SALT cap workaround as capital gains or 475 income. Creating earned income for employee benefits requires the S-Corp. A local accountant might follow their intuition and give wrong advice. TTS benefits are quirky and challenging to arrange correctly. This blog post should help and consider a consultation with a trader tax expert.

Executive Summary

What Is a Wash Sale?

A Simple Wash-Sale Example

Why Form 1099-B May Not Tell the Full Story

The IRA Wash-Sale Trap Can Make the Loss Permanent

Stocks, Options, ETFs, and Substantially Identical Positions

Do Wash-Sale Rules Apply to Cryptocurrency?

How Traders Can Break the Wash-Sale Chain at Year-End

Section 475 MTM Can Eliminate Wash-Sale Accounting for Qualified Traders

Reporting Wash Sales on Form 8949

Coming in October: Our Legal Wrapper Series

Bottom Line

Sources and Further Reading

Which tax forms do traders use?

TTS business expenses go on Schedule C

Securities without Section 475 use Form 8949 and Schedule D

The taxpayer is responsible for wash-sale reporting

Partnerships and S corporations may summarize Form 8949

Section 475 securities use Form 4797

Form 4797 requires transaction details

Segregate investment positions

Section 1256 contracts use Form 6781

Section 1256 loss carrybacks

Forex reporting depends on the contract and elections

Large Section 988 losses may require Form 8886

Digital assets bring new Form 1099-DA reporting

Broker forms are not always the final tax answer

Entity returns can provide cleaner reporting

Section 475 election procedures are strict

Section 475 revocations can be difficult

Common IRS notice triggers

Include tax-return footnotes

The bottom line

Bottom line

Why this companion article matters

Compliance note

Quick answers for active traders

Is there a minimum trade count for TTS?

Is 720 trades per year a legal threshold?

Is Section 475 the same as TTS?

GreenTraderTax Planning Benchmarks

TTS foundation cases

Key benchmark and caution cases

Section 475 election and mechanics cases

The six featured cases

1. Poppe — the best practical benchmark case

Practical takeaway

2. Crissey — helpful, but not a 500-trade rule

Practical takeaway

3. Assaderaghi — pattern matters more than totals

Pattern Matters More Than Totals

Practical takeaway

4. Nelson — substantiality and continuity still control

Practical takeaway

5. Obayagbona — trader facts do not fix a bad election

Practical takeaway

6. GWA — a technical but important Section 475 case

Practical takeaway

Holding periods and the 31-day benchmark

Practical takeaway

Section 475: separate from TTS

How traders should use these lists

Four practical reminders

2026 TTS Planning Checklist

When to get professional help

Final takeaway

Related content

In Essence

A Common Issue for Active Traders

IRS Position: RSU Stock Is Not Section 475 Property

Example: How Mismatched Character and the EBL Limit Create a Tax Trap

A Similar Trap for Traders with Investment Positions

Court Cases Reinforce the IRS Position

Broader Section 475 Mismatch Risks

Example: The Reverse Mismatch

Why Section 475(f) Still Matters

California Makes It Even Tougher

Audit Checklist: Section 475(f) and TTS Compliance Essentials

Need Professional Guidance?

Sources & Further Reading