The difference between filing your tax return as a trader and filing as an investor can be summed up in one word: DEDUCTIONS! If you qualify for trader status, you get to file a business tax return (Schedule C) and claim business expenses. This enables you to take many more deductions than you’d be able to take if you filed as an investor. Investors are severely limited under the tax code from deducting trading expenses.
Let’s look at a comparison side by side:
|
|
INVESTOR |
TRADER |
|
Capital Loss and Wash Sale
Rules Apply |
YES |
YES |
|
Investment Interest
Expense
|
LIMITED |
UNLIMITED |
|
Investment Expenses |
LIMITED |
UNLIMITED |
|
Where Are Expenses Taken?
|
SCHEDULE A |
SCHEDULE C |
|
Can Elect Mark to Market
Method of Accounting? |
NOT ALLOWED |
YES |
|
Home Office Expenses |
NOT ALLOWED |
YES |
|
Education Expenses |
NOT ALLOWED |
YES |
|
Depreciation of Computers
and Office Equipment |
LIMITED: SUBJECT TO 2% FLOOR |
YES |
|
Net Operating Loss
Carryback
|
NOT ALLOWED |
YES |
LIMITS ON EXPENSES
Looking at the above list you can see that filing your tax return as an investor limits the amount of expenses you are able to take. Since all expenses for an investor are filed on a Schedule A, they are classified as miscellaneous itemized deductions. This means that they must be greater than 2% of your adjusted gross income. It also means you can deduct only the amount over the 2% limit!
For example, if your AGI is $100,000, your expenses must be greater than $2,000 in order for you to deduct them. If your expenses are $3000, you can deduct only $1000 (the amount over the 2% limit) from your taxes.
Traders are not subject to this limitation since they will claim all of their business expenses on a Schedule C. This enables them to deduct ALL expenses associated with their trading business dollar for dollar!
LIMITS ON INVESTMENT INTEREST
Investors can deduct margin interest as an itemized deduction on their Schedule A but only to the extent of their net investment income. Any excess investment interest expenses are carried over to the following tax year to be deducted in the same way.
Traders are not subject to this limitation. They deduct margin interest in full on Schedule C as a business expense instead of an itemized deduction. Since margin interest for most traders can run many thousands of dollars, this is a HUGE tax advantage.
HOME OFFICE AND EDUCATION EXPENSES
Investors cannot deduct home office expenses or education expenses. This is another big tax savings for traders. Even if you rent your home or apartment, a trader can take the home office deduction, opening up thousands of dollars in tax savings every year!
MARK TO MARKET ACCOUNTING
One of the most beneficial aspects of trader tax status is the ability to claim mark to market accounting. If you make this election, your trading losses won't be subject to the $3000 capital loss limitation that investors are stuck with. Instead, your capital gains/losses are treated as ordinary gains/losses. Ordinary losses don't have a limit and can be used to offset any income. This is a huge benefit for a trader who has a bad year.
Click here to learn more about mark to market accounting.