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S-Corp versus an LLC as a trading vehicle
We have the following paragraph in our TRADER TAX RULES & TAX RETURN REPORTING GUIDE - EDITION 5
For 1998, an electing mark-to-market trader in securities can form and trade through an S-Corporation and thereby not be subject to future self-employment taxation on this ordinary income. S-Corp gains or losses flow-through to their owner's individual income tax returns. Flow-through income from a Schedule C, partnerships, and Limited Liability Companies (LLCs) is considered earned income (for owner/managers) for self-employment tax purposes. Our firm incorporates many new S-Corps and other legal entities through BizFilings (see our Web site greencompany.com, go to Legal & Incorporation, go to e*Commerce tax guide, go to Cybercorps). In our opinion, using an S-Corp. for your trading reduces IRS scrutiny (versus a Schedule C), gives you legal protection, and allows you to take more business expenses (contact us about this point).
Answer the question posted:
Here is an example. Taxpayer, who qualifies as a Trader in Securities, deducts 1997 year-end unrealized mark-to-market losses on Schedule C as ordinary losses. For tax year 1998, Trader Taxpayer starts the year with a lower cost basis for those mark-to-market securities (using the 1997 year-end market prices as his/her new cost basis). Trader Taxpayer sells those securities in 1998 and realizes a gain (net selling price less the 1997 year-end market price) due to the market recovery.
The important question is how do you report those realized gains. The tax law states that realized gains and losses are reported on Schedule D. The new holding period for these securities should start at 12/31/97 (because they were mark-to-market at the end of 1997).
Another question is whether you can designate these securities as long-term investments and hold them for long-term capital gain treatment. I'm not sure if the law is clear about whether you must consider these subsequent realized gains as ordinary gains to offset the ordinary losses taken in 1997. If you could get long-term treatment for the recovered gain, that would be tax abusive in theory. You would get ordinary loss in 1997 and possibly long-term capital gain in 1999.
If you are stuck in a position where you must report ordinary gains from trading on Schedule C, then you will be subject to self-employment taxes on your Schedule C net income. For that situation, if you convert your trading to an S-Corp., you should not be liable for self-employment taxes, because S-Corp. income is not considered self-employment income. LLC income is considered self-employment income.
Let's get some discussion on these questions and points. I invite Colin, Joel and the other helpful CPAs on these SI tax threads to help out here. I am too buried in tax season at the moment and will pick up this research after April 15th. I apologize for not giving a more complete answer now and "thinking aloud" at this point. |
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