Many people spend so much time building their investment portfolios that they consider it a part of their business strategy. However, not all people making regular business investments actually qualify to be taxed as traders (the official IRS name for professional investors). To qualify as a trader, and get the excellent tax benefits that come along with this profession category, the IRS requires that you meet some strict requirements.
What You Must Do to Be Labeled as a Trader
According to the IRS’s Topic No. 429 (Traders In Securities), there are three things you must do to be labeled a trader and four ways they evaluate this. The three qualifiers are: you must seek to profit from daily market movements in the prices of securities and not from dividends, interest, or capital appreciation; your activity must be substantial; and you must carry on the activity with continuity and regularity. To evaluate this, the IRS considers four things: your typical holding periods for securities bought and sold, the frequency and dollar amount of your trades during the year; the extent to which you pursue the activity to produce income for a livelihood; and the amount of time you devote to the activity.
Anyone who does not meet these qualifications cannot label themselves as a trader for tax purposes. Instead, they are called an investor (those investing but not for a trade or business) and will be taxed as such. Additionally, if you believe you qualify as a trader, you will need to be sure you keep thorough records, as the IRS requires proof of of qualification.
What Are the Advantages?
The advantages of being taxed as a trader rather than an investor are many. Perhaps the biggest is that you can use mark-to-market rules to report all your annual gains and losses for investments you haven’t yet sold. Under tax law, traders can also deduct all investment expenses, traders don’t have to pay self-employment tax on trading income, traders are not subject to the new $3,000 annual limit on capital loss deductions, and traders can often deduct home office expenses and supplies.
Clearly there are many tax benefits to being a trader rather than an investor. But if you are unsure whether or not you qualify, you likely don’t. If you don’t believe you qualify as a trader, it’s best to classify yourself as an investor rather than a trader to avoid filing incorrectly and risking an audit or other trouble with the IRS.
If you regularly trade investments and want to know whether or not you qualify as a trader, you can contact Vanguard Tax Relief for help analyzing your investment patterns. Our tax experts can help you understand how your business investments should be filed. Additionally, we also provide accountant services that can help you keep records and better manage your investment portfolio, whether you qualify as a trader or an investor.