Tax Forms And Compliance
Tax compliance is complex for traders with lots of different tax forms.
The IRS hasn’t created specialized tax forms for individual trading businesses. Traders enter gains and losses, portfolio income, business expenses and investment expenses on various forms. It’s often confusing. Which form should you use if you’re a forex trader? Which form is best for securities traders using the Section 475 MTM method? The different reporting strategies for the various types of traders make tax time not so cut-and-dried.
Sole proprietor trading business
Other sole-proprietorship businesses report revenue, cost of goods sold and expenses on Schedule C. But business traders qualifying for trader tax status (TTS) report only expenses on Schedule C. Trading gains and losses are reported on various forms, depending on the situation. In an entity, all trading gains, losses and expenses are consolidated on the entity tax return — a partnership Form 1065 or S-Corp Form 1120-S. That’s one reason why we recommend entities for TTS traders.
Sales of securities must be first reported on Form 8949, which then feeds into Schedule D (cash method) with capital losses limited to $3,000 per year against ordinary income (the rest is a capital loss carryover). Capital losses are unlimited against capital gains. (We cover Form 8949 in Chapter 4 of our tax guide.)
Business traders who elect and use Section 475 MTM on securities report their business trades (line by line) on Form 4797 Part II. MTM means open business trades are marked-to-market at year-end based on year-end prices. Business traders still report sales of segregated investments in securities (without MTM) on Form 8949. Form 4797 Part II (ordinary gain or loss) has unlimited business ordinary loss treatment and avoids capital loss limitations and wash sale loss treatment. Form 4797 losses are counted in net operating loss (NOL) calculations.
Section 1256 contract traders (i.e., futures) should use Form 6781 (unless they elected Section 475 for commodities/futures; in that case, Form 4797 is used). Section 1256 traders don’t use Form 8949 — they rely on a one-page Form 1099-B showing their net trading gain or loss (“aggregate profit or loss on contracts”). Simply enter that amount in summary form on Form 6781 Part I. If you have a large Section 1256 loss, consider a Section 1256 loss carryback election to carryback those losses three tax years, but only applied against Section 1256 gains in those years. If you want this election, check box D labeled “Net section 1256 contracts loss election ” on the top of Form 6781.
Forex traders with Section 988 ordinary gains or losses who don’t qualify for TTS should use line 21 (other gross income or loss) on Form 1040. Traders who qualify for TTS should use Form 4797, Part II ordinary gain or loss. What’s the difference? Form 4797 Part II losses contribute to NOL carrybacks and carryforwards against any type of income, whereas Form 1040’s “other losses” do not. The latter can be wasted if the taxpayer has negative income. In that case, a contemporaneous capital gains election is better on the Section 988 trades. If you filed the contemporaneous Section 988 opt-out (capital gains) election, use Form 8949 for minor currencies and Form 6781 for major currencies. Forex uses summary reporting.
An entity is better than a Schedule C
Partnership and S-Corp trading business tax returns show trading gains, losses and business expenses on one set of forms, plus the IRS won’t see the taxpayer’s other activities. That looks much better.
For more in-depth information on tax forms and compliance, read Green’s 2018 Trader Tax Guide.
Consider our tax compliance (preparation and planning) services.