Entity Solutions

Forming an entity can save active traders significant taxes.

Update July 1, 2021: Summer 2021 is an excellent time to form a new trading entity. There is still time to qualify for TTS on the entity level for the remainder of 2021, and Q4 is a minimum time period needed for TTS. The entity can make a late-year 475 election since the individual deadline has already passed. There’s time to make sufficient trading gains in an S-Corp to maximize a Solo 401(k) retirement plan contribution. The SALT cap workaround laws in several states are new, and a TTS trader needs a partnership or S-Corp to benefit. See our recent blog posts and webinar. 

How Some Traders Double-Up On Retirement Plan Contributions

Unlock State & Local Tax Deductions With A SALT Cap Workaround

Trader Tax Law: 2021 Mid-Year Update

Forming an entity can save active traders significant taxes. Active traders solidify trader tax status (TTS) for business expense deductions, unlock S-Corp employee-benefit deductions including health insurance and retirement plan contributions, gain flexibility with a late-year Section 475 election and revocation, ring-fence TTS/475 trading from individual-level investing, limit wash-sale losses with individual and IRA accounts, and provide a SALT cap workaround. An entity solution generates tax savings for many active traders over entity formation and tax compliance costs.

An entity tax return consolidates trading activity on a pass-through tax return (partnership Form 1065 or S-Corp 1120S), making life easier for taxpayers, accountants, and the IRS. It’s important to segregate investments from business trading when claiming TTS, and an entity is most useful in that regard. It’s simple and inexpensive to set up and operate. See our entity formation service.

Additionally, entities help traders elect Section 475 MTM (ordinary-loss treatment) later in the tax year — within 75 days of inception — if they missed the individual MTM election deadline on April 15 (May 17, 2021, for a 2021 election). And it’s easier for an entity to exit TTS and revoke Section 475 MTM than it is for a sole proprietor. It’s more convenient for a new entity to adopt Section 475 MTM internally from inception instead of an existing taxpayer who must prepare and file a Form 3115 after filing an external election with the IRS.

Don’t worry; prior capital-loss carryovers on the individual level aren’t lost; they still carry over on individual Schedule Ds. The new entity can pass through capital gains if the taxpayer skips the Section 475 MTM election to use those capital loss carryovers. Then, the entity can elect Section 475 MTM in a subsequent tax year.

Business traders often use an S-Corp trading company to pay salary to the owner in connection with a retirement plan contribution and health insurance deduction. Employee-benefit deductions are difficult to arrange in a partnership trading company, and it’s not possible for sole proprietor traders.

Trading in an entity can help constitute a performance record for traders looking to launch an investment-management business. Finally, many types of entities are useful for asset protection and business continuity. A separate legal entity gives the presumption of business purpose, but a trader entity still must achieve TTS for business deductions and employee benefits.

For more information, see Green’s Trader Tax Guide, Chapter 7, Entity Solutions.