Tax Advice for Clients Who Day Trade Stocks
The proliferation of retail has brought challenges as well as new opportunities for accountants. Since the tax rules surrounding day trading can be murky and complex, clients who daytime–Trade as a primary or secondary source of income may require the services of a tax professional. One important area where this ever-growing client group may need guidance is whether to do a Sec. 475 Mark–at–market election.
In this article, we offer some thoughts on day trading from a tax planning perspective. Practical examples are provided to illustrate the tax difference between the manufacture of Sec. 475 election versus not making the election.
THE POPULARITY OF DAY TRADING
Day trading generally refers to active trading by retail traders or owners who take short–term positions in any class of financial asset, including traditional stocks, bonds, currencies (including virtual currency), commodities, futures and, increasingly, options on these assets. Positions are typically held for as little as a few seconds (known as scalp trading) to several days (known as swing trading). The intention of the day trader, of course, is to buy an asset at a low price and sell it at a higher price in a short period of time (in the case of a long position; a short position does the same in reverse order).
A growing number of online brokers are providing software and platforms for day traders, who can use the brokerage’s margin loans to increase their buying power to sometimes three to four times their own equity. With the recent advent of Robinhood, one of the first online trading platforms to allow its retail clients to trade with $0 commissions, day trading has become accessible to the general public worldwide. The popularity of this lawsuit has caused several traditional banks and brokerages to follow suit and offer commission–free commerce to their retail customers in addition to a more expensive alternative that charges commissions for enhanced services. Doing commission–free trading available, these financial institutions see an opportunity to take advantage of the extension of margin lending to their trading clients.
In principle, day trading is like any other business in which stocks are bought lower and sold higher (i.e. buy low, sell high). One difference, however, is that in the financial space, a buy and a sell can be executed instantly, generating quick profits or losses. With the increased accessibility of day trading, training aimed at informing anyone interested in trading financial assets has multiplied in the market. the Internet.
As with any business, trading financial assets requires investments in equipment (e.g. hardware and software) and the payment of regular expenses, including commissions, platform fees, data charges, interest on margin–based loans and office expenses. Profit or loss from day trading has tax implications for others Income–generating activities.
DEALER IN SECURITIES
Generally, a day trader, due to the nature and scope of trading activities, will be treated for federal tax purposes as a securities dealer (i.e. a person who buys and sells securities for his own account). If a day trader qualifies as a securities dealer, they can do Sec. 475(f) Mark–at–market elections (see below).
However, a person will not be considered a trader in securities simply because they claim to be a trader or day trader or engage in a limited amount of trading activity of any kind. To qualify as a trader in securities, rather than an investor, an individual to have to:
- Seek to profit from daily market movements in security prices and not from dividends, interest or capital appreciation;
- Engage in substantial activity; and
- Pursue the activity with continuity and regularity (see IRS publication 550, Investment income and expenses, p. 68 (rev. 10 March 2022)).
If these requirements are not met, the person will be considered an investor and not a securities dealer whose trading activity is treated as a business. The determination of whether a person is a securities dealer is based on the facts and circumstances of their trading activity. Factors relevant to determining whether someone qualifies as a trader are discussed in IRS Topic #429 and summarized in the table “Distinguishing Traders from Investors” below.