Day trading taxes in the US may leave you scratching your head. However, if you mark hundreds or even thousands of intraday trades each year, it’s in your interest to understand how Uncle Sam will view your habits.

Not only could you face a mountain of paperwork, but those hard-earned profits will feel even worse when the Internal Revenue Service (IRS) has taken a slice. This page will break down the laws, regulations, and tax implications. It will cover asset-specific provisions, before concluding with top preparation tips, including tax software.

Investor vs Trader

So, how does weekday trading work with taxes? Intraday income tax depends on the category you enter, ‘trader’ or ‘investor’. Unfortunately, according to an IRS spokesperson, “The question is clear; the answer is no. ” Therefore, you need to follow the guidelines set out in the 70,000-page tax code and take decisions in the relevant case law.

 

Investors

If you don’t qualify as a trader, you may be seen as an investor in the eyes of the IRS. If this is the case, you will face unfavorable day trading tax rates in the United States. You will need to account for your gains and losses on form 8949 and Schedule D. Your expenses will fall under the category of “miscellaneous itemized deductions.”

This means you won’t be able to claim the homestead deduction and you must depreciate the equipment over several years, instead of doing it all in one go. Also, on Schedule A, you will combine your investment expenses with other miscellaneous items, such as the costs incurred in tax preparation. You can also write off amounts that exceed 2% of your adjusted gross income.

Classification

The first step in day trader tax reporting is determining which category you will fit into. Investors, like traders, buy and sell securities. However, investors are not considered to be trading or the business of selling securities. Instead, their benefits come from interest, dividends, and capital appreciation of the securities they choose.

The key difference between whether you are entitled to a page 1 deduction, as opposed to a Schedule A deduction against income, lies in whether you are in the ‘trade’ or ‘business’ of selling securities.

The bad news is that no long tax code is clearly ‘trade’ or ‘business’. Instead, you must look at recent case law (detailed below), to identify where your activities fit.

Merchant

Do you spend time buying and selling your assets? If so, you may fall under the ‘trader’ umbrella. A title that can save you serious cash when filing your tax return.

Classification

Day trading tax law and recent cases tell us that you are a ‘trader’ if you meet the requirements tested in Endicott vs Commissioner, TC Memo 2013-199. Both considerations are as follows.

In this case, the taxpayer’s primary strategy is to buy shares of stock and then sell call options on the underlying stock. The goal is to profit from the premium received from selling the call option against the quantity related to the underlying stock it holds.

He usually sells call options that hold expiration dates between one and five months. Endicott hopes the option will expire, allowing the amount of premium received for profit. He does not trade options every day, as a result of the high commission costs that come with selling and buying call options.

Endicott then deducts his business-related expenses on Schedule C. This reduces his adjusted gross income. However, the IRS disagreed with the deductions and instead moved them to Schedule A. They insisted Endicott was an investor, not a trader.

Number of Trades

One of the first things the tax court looks at when considering the criteria outlined above is how many trades the taxpayer carries out per year. They also look at the amount of money involved in the trade, as well as the number of days in the year the trade is executed.

Endicott made 204 trades in 2006 and 303 in 2007. Then in 2008, he made 1,543 trades. The court ruled that the trading volume was not high in 2006 and 2007, but in 2008.

Total amount of money

In 2006 Endicott made purchases and sales that totaled around $7 million. In 2007, the amount was almost $15 million, and in 2008 it was about $16 million. The court agreed that this amount was a lot. However, they also stated, “managing a large sum of money is not conclusive as to whether the petitioner’s trading activities amount to trade or business.”

Main topic

From this case and recent tax regulations in the US, a clearer picture of what is required to meet the definition of ‘trader’ emerges. The most important are as follows:

  • You spend a large amount of time trading. Ideally, this will be your full-time job. If you are a part-time trader, you need to buy and sell several assets every day.
  • You can show regular patterns to make high volume trades, ideally almost every day the market is open.
  • Your goal is to profit from short-term price fluctuations, not long-term profits.

Benefits of ‘Trader’

US day trading tax rates look good on ‘traders’. Therefore, meet the vague classification requirements if you can. This is because from the perspective of the IRS, your activity is a self-employed individual. This allows you to deduct all of your trade-related expenses on Schedule C.

This includes home and office equipment. It includes educational resources, phone bills and various other costs. However, it is important that you keep receipts for any items, as the IRS may request evidence to prove they were used solely for commercial purposes.

On the other hand, if you are categorized as a trader, you can write off only the amount that exceeds 2% of your adjusted gross income. Not to mention that eliminating Schedule C will adjust your gross income, increasing the likelihood that you can fully deduct all of your personal exemptions, as well as take advantage of other tax breaks that will be eliminated for higher levels of adjusted gross income.

Then there’s the fact that you can deduct your margin account interest on Schedule C. Throw in the fact that you don’t have to pay self-tax on your net profit from the trade, and you realize, that’s a pretty sweet deal.

Mark-To-Market Traders

There are other advantages that are distinct and center around the day trader tax deduction. Normally, if you sell an asset at a loss, you can write off the amount. However, if you, your spouse, or your controlling company buys the same stock within 30 days, the IRS considers this a ‘wash sale’ (more details below). This brings it a big tax headache.

Fortunately, you can jump this hurdle if you become a ‘mark-to-market’ trader. This will see you automatically exempt from the wash sale rules.

Here’s what you do: On the last trading day of the year, you pretend to sell any and all holdings. You still hold the asset, but you book all imaginary gains and losses for the day. You will then enter the new year with unrealized gains or losses. It will appear as if you have just bought back all the assets you pretended to sell.

This brings different benefits, in terms of taxes on day trading profits. Typically, investors can deduct only $3,000 or $1,500 in net capital losses each year. However, market traders can deduct unlimited losses. If you have a poor trading year, this can save you a lot of money.

If you qualify as a market-to-market trader, you should report your gains and losses on part II of IRS form 4797. For more information, see IRS Revenue Procedure 99-17 in Internal Revenue Bulletin 99-7.

Buying and Selling Rules

There is one important point that focuses on day trader tax losses. In particular, the ‘wash sale’ rule. This rule is set by the IRS and prohibits traders from claiming losses for the sale of security trades in wash sales.

A wash sale occurs when you manage a security at a loss, and then within thirty days either side of the sale, you, your partner, or your partner buys a ‘very similar’ instrument. If the IRS denies the loss as a result of this rule, you will have to add the loss to the cost of the new security. This will then be the cost basis for the new security.

For more guidance on these rules and important American trade rules and regulations, see our rules page.

Application

So, how to report tax on trading days? If you are a trader, you will report your gains and losses on form 8949 and Schedule D. You can deduct only $3,000 in net capital losses each year. However, if you are married and using separate filing status then $1,500.

Schedule C then has only expenses and zero income, while your trading profits are reflected on Schedule D. To avoid any confusion, it’s a useful tax tip to include a statement detailing your situation.

You can’t join the most successful traders in the country, like Bruce Kovner and George Soros if you fall on the tax hurdle. So pay the same attention to your tax return in April as you do the market all year.

Example

While it may not be obvious, below is a typical scenario to help you see where your activity might fit.

  • Example 1 – Let’s say you spend 8-10 hours trading a week and average around 250 sales a year, all within days of your purchase. The IRS is likely to say you don’t spend enough time trading to meet the ‘trader’ criteria.
  • Example 2 – Let’s say you spend around 20 hours a week and average around 1,250 short-term trades in a year. The IRS can’t put up a fight if you declare your acquisition as a day trader on your tax return.

It is also worth remembering that you can be a ‘trader’ and an ‘investor’. However, if you go this route, you will need to separate your long-term holdings and keep detailed records to distinguish between the two sets of activities.

Tax Terminology

You can’t get past trade taxes in the United States without understanding important jargon terms. Some of the terms that will often come up are as follows:

Cost Basis

This represents the amount you paid upfront for the security, including commission. It serves as the base figure from which taxes on day trading profits and losses are calculated. If you close your position above or below your cost basis, you will make either a capital gain or a loss.

Capital gains

A capital gain is only when you make a profit from selling a security for more money than you paid for it, or if you buy a security for less money than you received when selling it short. Both traders and investors can pay tax on capital gains.

Normally, if you hold your position for less than a year, it will be considered a short-term capital gain, and you will be taxed at the normal rate. However, hold office for more than a year and you can benefit from a lower tax percentage rate, often around 15%, but depending on your income, can also drop to just 5%.

Capital Loss

A capital loss is when you incur a loss when you sell a security for less than you paid for it, or if you buy a security for more money than you received when you sold it short. You will often find tax purposes for day trading, you can write off (deduct) capital losses, up to the number of capital gains you make this year.

If you have more losses than gains in a year, you can write off an additional $3,000 on top of your offset gains. If your losses exceed an additional $3,000, you have the option to carry those losses forward to the next tax year where you will have an additional allowance of $3,000.

 

 

Asset Specific Tax

With the huge differences between the instruments, many ask if there are different tax rules that you should be aware of if you trade in multiple instruments. However, overall, the IRS cares more about why and how you trade, than what you trade.

Therefore, day trading options and foreign exchange taxes in the United States are usually the same as stock taxes. Having said that, there are some asset specific rules to be aware of.

Forward

Profits and losses under futures tax follow the ’60 / 40′ rule. The rate you will pay on your profits will depend on your income. 60% of the gain is treated as long-term capital gain at a rate of 0% if you fall in the 10-15% tax bracket. If you fall into the 25-35% tax bracket, it will be 15%, and it will be 20% if you fall into the 36.9% tax bracket. 40% of the gain is considered short-term and will be taxed at your ordinary income tax rate.

So, overall, the tax implications of forex trading in the US will be similar to tax trading in stocks, and most other instruments. Although futures options can come with some interesting provisions, the main concern for all instruments is around ‘trader’ vs ‘investor’ status.

Tax Preparation

Keep records

Many traders reach mid-April and suddenly realize the IRS not only wants to know your profit and loss on each sale, but they also want a detailed explanation. If you want a direct trade tax rate, you need to keep the following records:

  • Tool
  • Price
  • Date of purchase & sale
  • Size
  • Entry & exit points

Having this information on hand will make trading US stocks a stress-free procedure.

Day Trader Tax Software

There is now trade tax software that can speed up the filing process and reduce the possibility of errors. This tax preparation software allows you to download data from online brokers and organize them in an easy way. In short, it makes plugging the numbers into a tax calculator a walk in the park.

This frees up time so you can focus on turning your profit from the market. Shifting traders will take advantage of this new technology to improve their overall trading experience.

Final Word

Day trading and taxes do not go well together in the United States. Taxes on income will vary depending on whether you are classified as a ‘trader’ or ‘investor’ in the eyes of the IRS. Unfortunately, very few qualify as traders and can reap the benefits it brings. For those tempted to alter their records to pursue a ‘dealer’ classification, be warned the consequences of failing to pay the correct amount, or late payment, can result in severe disability. This can range from financially crippling fines and even jail time.

Note this page does not attempt to offer tax advice. It just looks to clear the sometimes murky waters surrounding the intraday income tax. If you remain unsure or have other questions about day trading with taxes, you should seek professional advice from any accountant or the IRS.