Irby & Steve: Discussion of Trader Status
This is the lastest references to your discussion on Trader Status from CCH Tax Service as of February Release.
Traders
The gains and losses from a trader's securities transactions are capital. Who is a trader is not defined in the Code or through regulations, but
has been defined by the courts. The definition of a trader falls between the definition of a dealer and an investor. A trader is someone who
trades a large volume of transactions on a regular basis but does not have customers.83 The trader speculates and trades for his own account
for investment. A trader is considered to be in a trade or business that produces capital gains and losses rather than ordinary income and
losses.84 The deductible expenses of a trader are ordinary and necessary business expenses. A trader's expenses are not subject to the floor of
2 percent of adjusted gross income imposed on miscellaneous itemized deductions, which include expenses of an investor.85See Chapter A:12
for discussion of the 2-percent floor on miscellaneous itemized deductions. A trader can deduct interest expenses in excess of net investment
income.86 See Chapter A:16 for discussion of the limitation on deducting investment interest. A trader must capitalize interest and carrying
costs properly allocable to personal property that is part of a straddle that is not a hedging transaction, and that is either part of a larger
straddle or includes property other than a qualified covered call option and the stock to be purchased under that option.87 See Chapter E:16 for
discussion of straddles.
83 King v Commr, 89 TC 445 (1987); Groetzinger v Commr, 771 F2d 269 (7th Cir 1985), 85-2 USTC 9622, 56 AFTR2d 85-5683, affd 480
US 23 (1987); Nehring v Commr, TC Memo 1957-51, 16 TCM 224, 57,051 P-H TC Memo; LaBorde v Commr, TC Memo 1988-58, 55 TCM
119, 88,058 P-H TC Memo.
84 King v Commr, 89 TC 445 (1987).
85 IRC 67.
86 IRC 163(d); King v Commr, 89 TC 445 (1987).
87 See IRC 263(g)(1) through (3), 1092(c), 1256(e).
Characterization of gain or loss does not depend on the number of transactions or degree of activity of the trader. The governing factor is
whether the securities sold were capital assets in the hands of the taxpayer.88
88 Commr v Burnett, 118 F2d 659 (5th Cir 1941), 41-1 USTC 9347, 26 AFTR 893; Mirro-Dynamics Corp v US, 374 F2d 14 (9th Cir 1967),
67-1 USTC 9324, 19 AFTR2d 1029, cert denied 389 US 896; Adnee v Commr, 41 TC 40 (1963).
Comment: A trader treats gains and losses from a security transaction the same as an investor does, unless he makes the mark-to-market
election for securities traders available for tax years ending after August 5, 1997.89 See E:15.165. Thus, if the transaction is not entered into
with Section 1256 contracts, the transaction generates short-term or long-term capital gain or loss when the security involved is sold or
exchanged, depending on how long the trader has held it. In addition, after June 8, 1997, an offsetting transaction may also cause a
constructive sale of an appreciated financial position.90 See E:15.200. If the transaction is entered into with Section 1256 contracts, the
transaction generally generates capital gain or loss as well, but is subject to the mark-to-market rules and automatic 60-percent/40-percent
allocation between long-term capital gain or loss and short-term capital gain or loss. See E:15.41 and Chapter E:16.
89 IRC 475(f)(1); Pub L No 105-34, 105th Cong, 1st Sess, 1001(d)(4)(A) (Aug 5, 1997).
90 IRC 1259; see Pub L No 105-34, 105th Cong, 1st Sess, 1001(d) (Aug 5, 1997).
Comment: Because they are marked to market Section 1256 contracts are not subject to the constructive sale rules for appreciated financial
positions.91 See E:15.200 for discussion of constructive sales of appreciated financial positions.
91 See IRC 1259.
Comment: The long-term capital gain status of 60 percent of the gain from Section 1256 contracts should not be confused with the status of
adjusted net capital gain on certain capital assets held for more than 18 months that generally is eligible for maximum rates of 20 percent or 10
percent for noncorporate taxpayers after May 6, 1997.92 The long-term holding period for these contracts is defined by reference to the
standard long-term capital gains holding period.93 Even the transitional rule, under which capital assets sold between certain dates may be
eligible for the lower rates although not held for more than 18 months, contains its own requirement of more than one year and does not refer
to the standard Code definition94 of long-term capital gain.95 See Chapter E:5 for discussion of capital gains and losses.
92 See IRC 1(h).
93 See IRC 1222.
94 IRC 1222.
95 See IRC 1(h)(8).
Distinguishing characteristics of a trader include the following:
l A trader purchases and sells securities frequently to catch the daily market movements and to profit on a short-term basis.96
96 Liang v Commr, 23 TC 1040 (1955).
l A trader's profits are derived through direct management of purchasing and selling.97
97 Purvis v Commr, 530 F2d 1332 (9th Cir 1976), 76-1 USTC 9270, 37 AFTR2d 76-968.
l A trader does not perform merchandising functions or any services that need be compensated, and does not have any customers.98
98 Kemon v Commr, 16 TC 1026 (1951).
l A trader engages in a continuous volume and magnitude of purchases and sales;99 the amount of time spent on trading is important to
trader status.100
99 Ferguson v Commr, TC Memo 1974-244, 33 TCM 1082, 74,244 P-H TC Memo.
100 Chemical Bank & Trust Co v US, 21 F Supp 167 (Ct Cl 1937), 37-2 USTC 9518, 20 AFTR 419.
l A trader's activities are directed to short-term trading, not the long-term holding of investments, and income principally is derived from the
sale of securities rather than from dividends and interest paid on those securities.
Relevant considerations in determining whether a taxpayer is a trader or investor are the taxpayer's investment intent, the nature of the
income to be derived from the activity, and the frequency, extent, and regularity of the taxpayer's securities transactions.101
101 Purvis v Commr, 530 F2d 1332 (9th Cir 1976), 76-1 USTC 9270, 37 AFTR2d 76-968.
Comment: The standard characteristics that courts use in determining trader status in fact leave many questions unanswered, such as what
in particular is meant by the frequency, extent and regularity of transactions that identify the person entering into them as a trader rather
than an investor.
In the following cases the taxpayer's activity did not rise to the level of a trade or business and the taxpayer was treated as an investor:
l A registered brokerage representative that had only 29 purchases and 22 sales transactions during the year was not a trader, and the
securities purchased for his own account were not incurred in connection with a trade or business.102
102 Asch v Commr, TC Memo 1986-238, 51 TCM 1167, 86,238 P-H TC Memo.
l A stockbroker managed his family's investments, carefully investigated companies before he purchased stock, and would generally hold
the stock for long-term appreciation. He treated dividends from the securities purchased as personal service income. The Tax Court found
that the taxpayer was merely an investor managing his investments and not an active trader in securities engaging in a trade or
business.103
103 Beals v Commr, TC Memo 1987-171, 53 TCM 492, 87,171 P-H TC Memo.
l A taxpayer's sole occupation was trading his own account and was conducted from an office at a brokerage firm, which allowed him the
use of a secretarial pool and telephone and access to its research staff and other facilities. He had over 1,000 purchase and sales
transactions for over 1 million shares of stock in the companies in which he invested. The Tax Court, as affirmed by the Second Circuit,
held that despite the taxpayer's extensive market activities and his generally professional attitude toward his stock holdings, the fact that
a majority of his positions were held for more than 12 months indicated that he was not a trader.104
104 Est of Louis Yaeger v Commr, TC Memo 1988-264, 55 TCM 1101, 88,264 P-H TC Memo, affd 889 F2d 29 (2d Cir 1989), cert denied 495
US 946.
l A taxpayer averaged over 1,000 trades per year but primarily sought to profit through capital appreciation, dividends and interest. Both
the Tax Court105 and the Court of Federal Claims,106 ruling on different tax years but essentially the same facts, held against him when his
securities had a weighted average holding period of over nine months, with about two thirds of the securities being held for over six
months and less than 6 percent being held for 30 or fewer days. In addition, he did not direct the trades himself but instead hired at least
eight money managers to whom he made clear his investment objectives in writing, and who had discretionary authority over the trades
and were given three to five years without interference to prove themselves.
105 Mayer v Commr, TC Memo 1994-209, 67 TCM 2949, 94,209 TC Memo.
106 Mayer v US, 32 Fed Cl 149 (1994), 94-2 USTC 50,509, 74 AFTR2d 94-6402.
High-volume short-term trading is not generally viewed as an adjunct or secondary occupation since short-term trading at high volume is
risky. Therefore, a high-volume trader is distinguishable from a low-volume trader. Consequently, there is an equitable basis for according a
high-volume trader different tax treatment than that accorded an investor who occasionally engages in a short-term trade.107
107 Groetzinger v Commr, 771 F2d 269 (7th Cir 1985), 85-2 USTC 9622, 56 AFTR2d 85-5683, affd 480 US 23 (1987).
The distinction between trader and/or dealer classification also rests on a factual inquiry, as illustrated by the following cases:
l A partnership formed for the principal activity of buying and selling unlisted securities for its own account listed itself as a dealer on its
tax return. The partnership had between 7,000 and 8,000 transactions each year. It did not have a board room or salesmen, nor was it an
underwriter in securities. The Tax Court held that the partnership was a trader holding securities primarily as a speculator and investor for
itself, since it did not maintain an inventory or have customers.108
108 Kemon v Commr, 16 TC 1026 (1951).
l A taxpayer who bought and sold substantial amounts of stocks and bonds was not a dealer in securities because he had no customers,
was not licensed to sell securities, did not have a seat on any exchange, traded only for his own account, and handled all his transactions
through a broker. He was a trader in securities and the securities in his hands were capital assets.109
109 Huebschman v Commr, TC Memo 1980-537, 41 TCM 474, 80,537 P-H TC Memo.
l The sale of stock by a syndicate to an underwriting group was not property held for the sale to customers of either the syndicate or its
members in the ordinary course of the trade or business of either, even though some members were dealers. It was held as an investment.
Therefore, the sale of the stock was the sale of a capital asset.110
110 Currie v Commr, 53 TC 185 (1969), acq 1970-1 CB xv; Lahman v Commr, TC Memo 1969-239, 28 TCM 1244, 69,239 P-H TC Memo;
Turner v Commr, TC Memo 1969-240, 28 TCM 1252, 69,240 P-H TC Memo.
l A partnership in the real estate business used surplus funds to trade in securities for its own account through a broker. The partnership
was not treated as a dealer because it was not regularly engaged in the sale of securities to customers.111
111 Adnee v Commr, 41 TC 40 (1963).
l A taxpayer, a registered broker-dealer, was a trader, not a dealer, because the stock was acquired and held for investment and the
purchaser was not a usual customer of his securities business.112
112 Turner v Commr, TC Memo 1969-240, 28 TCM 1252, 69,240 P-H TC Memo.
l A taxpayer, an auto designer, traded in silver futures and stock through a broker. He had no customers regularly purchasing futures or
stock from him, he was not licensed to sell securities, and he was not a member of an exchange. Therefore, losses sustained were capital
because he was treated as a trader.113
113 Kozikowski v Commr, TC Memo 1986-364, 52 TCM 148, 86,364 P-H TC Memo.
l A corporation trading in securities for its own account through a broker was not a dealer.114
114 Trading Assocs Corp v Magruder, 112 F2d 779 (4th Cir 1940), 40-2 USTC 9519, 25 AFTR 290.
Traders are subject to limitation rules for short sales (see E:15.60) and wash sales (see E:15.80). Although a trader does not maintain an
inventory, he is subject to identification rules to determine a basis for the securities sold. See Chapter E:2.
For tax years ending after August 5, 1997,115 traders in securities or traders in commodities may elect the same mark-to-market treatment that
applies to dealers in securities, except that a trader does not maintain an inventory that must be marked to market.116 See E:15.165.
115 Pub L No 105-34, 105th Cong, 1st Sess, 1001(d)(4)(A) (Aug 5, 1997).
116 IRC 475(f).
Comment: Although a trader and an investor treat gains and losses the same way, a taxpayer may prefer when possible to qualify as a trader
because a trader is not subject to the 2-percent floor on itemized deductions and is not subject to the investment interest expense limitation.
See Chapter A:13 for discussion of miscellaneous itemized deductions subject to the 2-percent floor and Chapter A:16 for discussion of the
itemized deduction for investment interest. A trader also generally can exclude trading gains and losses when computing self-employment
income.117 However, a trader must compute self-employment income by including gains and losses from dealing in or trading Section 1256
contracts when the trader is an options dealer or commodities dealer.118 See Chapter A:23 for discussion of self-employment income. A
dealer's investment account transactions may qualify for trader status if the nature and extent of the activity meet the judicial characteristics
of the trader definition.
117 IRC 1402(a)(3)(A).
118 IRC 1402(i).
As you can see, the rules are not well defined! I will attempt to find more as time permits . . . If you like.
FWIW, In light of the current code and court rulings, I personally believe Steve has the luxury of choosing either or the two methods "Investor" or "Trader" as a GOOD Tax Atty or Accountant should be able to defend either position he wants to take. I am making this statement on the limited knowledge of Steves personal situation (i.e. I recall that at sometime in the past he made the statement that he held some of his "trades" or at least a portion of a "trade" as a longer term investment).
One other comment to this already lengthy post. Steve mentioned that he would like to be able to deduct expenses for online services & computers used at home. In HIS particular situation, there are other ways to skin that cat without electing to be classified a trader.
Monty |
