Tax Forms And Compliance

Tax compliance is complex for traders with lots of different tax forms.

The IRS uses multiple tax forms for trading businesses eligible for trader tax status (TTS). It can be confusing to taxpayers, accountants, and the IRS. Traders enter gains and losses, portfolio income, and business expenses in various tax forms. Which tax form or schedule should a forex trader use? It depends on their circumstances. Which form is correct for securities traders using the Section 475 MTM method? Can trading gains be reported directly on Schedule C? The different reporting strategies for the various types of traders make tax time not so cut and dry.

SOLE PROPRIETOR TRADING BUSINESS

Most sole-proprietorship businesses report revenue, cost of goods sold, and expenses on Schedule C. But business traders qualifying for TTS report only trading business expenses on Schedule C. Trading gains and losses are reported in other tax forms, depending on the situation. They can consolidate trading gains, losses, and business expenses on an entity tax return — a partnership Form 1065 or S-Corp Form 1120-S.

Sales of securities for each trade (no summary reporting) are reported on Form 8949, which 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.)

TTS traders who elect and use Section 475 MTM on securities report each securities trade on Form 4797 Part II. MTM means open securities trades are marked-to-market at year-end prices. Traders still report sales of segregated investments in securities (without MTM) on Form 8949 and Schedule D. Form 4797 Part II receives ordinary gain or loss treatment avoiding the capital loss limitation and wash-sale loss rules. Form 4797 losses that cause negative taxable income are counted in net operating losses (NOL). The 20% qualified business income (QBI) deduction includes Section 475 gains and excludes capital gains and portfolio income.

Section 1256 contract traders (i.e., futures) should use Form 6781 (unless they elected Section 475 for commodities/futures; those are reported on Form 4797). 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”). That amount is entered in summary format on Form 6781 Part I.

For sales of cryptocurrencies, use Form 8949, but not wash sales or Section 475 MTM.

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