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

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

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

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

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Original post

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

CARES allows five-year NOL carrybacks
Starting with the 2018 tax year, TCJA repealed two-year NOL carrybacks and only allowed NOL carryforwards limited to 80% of the subsequent year’s taxable income. TCJA introduced the “excess business loss” (EBL) limitation, where aggregate business losses over an EBL threshold ($500,000 for married and $250,000 for other taxpayers for 2018) were considered an NOL carryforward. TCJA deferred losses into the future.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Darren Neuschwander CPA contributed to this blog post.