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Strategies & Market Trends : The Final Frontier - Online Remote Trading -- Ignore unavailable to you. Want to Upgrade?

To: PitBull who wrote (1641)	12/8/1997 11:40:00 AM
From: TFF	Read Replies (1) \| Respond to of 12617

Enthusiastic: To: Maureen (39 ) From: Scott Edwards Monday, Mar 17 1997 10:32PM EST Reply # of 82 Maureen, The following discussion is intended for discussion purposes and should not be construed as tax or legal advice. I have prepared the analysis more as a stepping stone and for those of you who think you may qualify based on what I have written, please seek professional advice as to the applicability of the rules to your specific fact scenario. The following analysis is based on my reading of Commerce Clearing House's interpretation of the tax laws regarding traders. It is meant as a general discussion of the rules and anyone who is interested in how these rules are applicable to their individual situation should seek the advice of their individual CPA or tax attorney. From what I have read this area is rather gray. The definitions used in determining whether or not someone is a trader are not codified and therefore the definitions come from Court rulings that are applicable to a single set of facts. Everyone's individual situation will be different and what may apply to one individual may not apply to another, even though their situations appear identical. In this area it does appear that small factual changes will change the outcome under the tax laws. There are three definitions: 1)Investor, 2)Trader and 3)Dealer. I will only gloss over the dealer definitions as the investor and trader definitions appear to be what is important to the thread. An investor reports the gains and losses from their stock or securities, equity options, non-equity options and futures contracts as capital gains and losses. The nonequity options and futures contracts are marked to market at the end of the tax year and are treated as 60 long term gain/loss and 40 short term gain/loss. Any expenses are treated as income producing expenses and are miscellaneous itemized deductions subject to the 2% rule. A trader treats the gains and losses the same as an investor, but the expenses are now business expenses and are not subject to the 2% floor on miscellaneous itemized deductions. A dealer treats the gains and losses from stock or securities transactions as ordinary income and from equity and nonequity options as capital subject to the marked to market rules and the 60/40 split. A dealer's expenses are business expenses not subject to the 2% floor. It appears that the primary difference between an investor and a trader is the frequency with which trades occur, the intent of the trading an the personal management of one's account. Someone who engages in extensive securities activity can be an investor, not a trader, if they do not seek a profit primarily from daily swings in the market, nor if they do not personally engage in or direct the buying and selling of the securities. If the motive is to seek profit through capital appreciation, dividends and interest then the classification will probably be investor. The distinction appears to be that capital appreciation is deemed to be a longer term perspective, even though the transaction may close within one tax year and be deemed short term capital gain. An individual who engaged in over 1,000 transaction during the course of the year was deemed an investor, in part because the average holding period was nine months. The case noted that about two thirds of his securities were held over six months and less than 6% were held 30 days or less. I would not hang my hat on the 30 days or less as designating a trader, but that was the language the court used. Another part of his problem was that he had professional money managers handle his account. Some of the characteristics of a trader include: -- buying and selling frequently to catch the daily market moves. -- profits are derived from direct management by the trader of his/her account. -- a trader does not perform merchandising functions and does not have any customers, a dealer does. -- a trader engages in a continuous volume of buying and selling and the amount of time spent is important. -- income is primarily derived from the purchase and sale of securities and not dividends and interest. -- the intent of the taxpayer, the nature of the income, the frequency, extent, regularity and time spent are all factors to be weighed. -- high volume trading is not treated as a secondary or adjunct profession. This indicates to me that not only must the income be substantial, the trader must be available during market hours on a consistent basis to make the trades. There are big benefits to gaining the trader status. The first has already been mentioned. The investment expenses are not subject to the 2% floor on itemized deductions. The second is that the investment interest limitations do not apply. The third is that the gains and losses are excluded from calculating self-employment income. (This one is amazing to me. It seems to me that almost all income from a trade or business is subject to the self-employment/social security tax. To let traders around this rule is having your cake and eating it too.) So it appears that the gains and losses are reported on Schedule D as usual. The investment expenses are reported on a Schedule C and carry to the Form 1040 so as to be a deduction in order to arrive at adjusted gross income. The rule stating that the investment interest limitations do not apply to a trader was mentioned in passing with no reference to a Code section or other ruling. This is somewhat puzzling to me. Does this mean that the investment interest is deducted on Schedule C as a trade or business expense or does it mean that it is still deducted on Schedule A and an itemized deduction, but that the limitation does not apply? I did not look further into that as time limitations do not permit it. There are also special interest and carrying cost capitalization rules for some straddle transactions and other transactions that I did not look into. It is obvious from the above that this is a thorny issue. I have not researched every possible scenario and therefore must again state that each individual's circumstances must be examined to determine the applicability of these rules. This is not an area I would recommend anyone venture into without the guidance of a tax professional. Let me state that I have had four years of undergraduate study, three years of law school and eight years of practical experience and it is obvious to anyone who has read my posts on this thread that I am still learning. The tax code is fraught with gray areas and contradictions. Do not take what I have stated above as conclusive. I hope this helps some of you determine whether or not this may be an issue for you. If you believe it is have your tax professional review your individual circumstances to see if it applies. Scott