Different Types Of Traders

This page looks at the different tax matters for casual investors, active traders, traders eligible for trader tax status, proprietary traders, and investment managers.

“Trading” is a widely used term covering everyone from the casual investor with a dozen trades per year to the active investor with a few hundred, to the business trader eligible for trader tax status with over seven hundred, to proprietary traders using a proprietary trading firm’s capital, to investment managers trading for their investor clients. Let’s take a look at the various types of traders. 

Casual Investor 

Millions of Americans have online brokerage accounts, and they make a dozen or more trades per year. They need to deal with cost-basis reporting on securities and make wash sale loss adjustments and tax treatment for various financial instruments. They can expect to have some issues with consumer tax software and tax storefront services. For example, a local tax advisor may need help knowing where to report forex transactions and how best to handle wash sale reporting on securities. In 2018, the new tax law TCJA suspended investment expenses, except investment interest.

Active Investor 

Many online traders have several hundred trades yearly but fall short of claiming trader tax status (TTS). The Poppe tax court approved 60 monthly transactions, for a total of 720 per year, annualized. Active investors often have another job or business activity and need more time to trade for a living. They have more tax issues than the casual investor, including wash sale loss adjustments and complex tax treatment issues as they trade a wider variety of instruments, and they keep a close eye on TTS qualification. With TCJA suspending investment expenses, TTS is more critical than ever before.

Retail Trader Eligible for Trader Tax Status

A small minority of online traders qualify for trader tax status (TTS). They should master the content in our Trader Tax Center, read Green’s Trader Tax Guide, and consider our full array of services targeted to their unique needs. With proper tax planning, TTS traders can maximize business expense treatment and elect Section 475 MTM ordinary gain or loss treatment. TTS traders are also eligible for a 20% qualified business income (QBI) deduction. They can form an S-Corp to unlock employee benefit plan deductions, including health insurance and a retirement plan. With a TTS partnership or S-Corp, they can do the SALT cap workaround solution. (Read Trader Tax Status in our Trader Tax Center.) The full works!

Proprietary Trader 

Traders needing more capital are attracted to proprietary trading firms, which are known to offer traders far greater leverage in return for low deposits or upfront payments. Prop firms invite traders to join their company in one of two ways. Some prop trading firms register as non-customer broker-dealers, and regulators prefer prop traders as LLC members. These LLC-member traders receive an annual Schedule K-1 with their allocation of net trading gains. Other prop firms interconnect with an education business. After paying for teaching and passing tests, these companies may invite graduates to become independent-contractor (IC) traders earning non-employee compensation reported on an annual tax Form 1099-NEC. (Read Proprietary Trading in our Trader Tax Center.)

Investment Managers 

Investment management is when you trade money belonging to investors in return for compensation, including a share of profits. As you can imagine, handling other people’s money is a serious business, and there is a vast body of investor-protection laws and regulations on securities, commodities futures, and forex. The investment manager may need to obtain various licenses and register with the appropriate regulators. (Read Investment Management Services for more information about regulation.) Investment managers handle two types of investors: separately managed accounts (SMAs) and hedge funds (commodity or forex pools). In an SMA, the client maintains a customer account, granting trading power to the investment manager. In a hedge fund, the investor pools his money for an equity interest, receiving an annual Schedule K-1 to allocate income and expenses. Hedge funds use carried-interest provisions to help investors navigate the suspension of incentive fees as itemized deductions. (Read Investment Management in our Trader Tax Center.)

For more in-depth information on different types of traders, read Green’s Trader Tax Guide.